Exchange Rate Flexibility and Credit During Capital Inflow Reversals: Purgatory…Not Paradise

31 Pages Posted: 15 May 2014

See all articles by Nicolás E. Magud

Nicolás E. Magud

International Monetary Fund (IMF)

Esteban Vesperoni

International Monetary Fund (IMF); University of Maryland, College Park

Date Written: April 2014

Abstract

We document the behavior of macro and credit variables during episodes of capital inflows reversals in economies with different degrees of exchange rate flexibility. We find that exchange rate flexibility is associated with milder credit growth during the boom but, even though smaller than in more rigid regimes, it cannot shield the economy from a credit reversal. Furthermore, we observe what we dub as a recovery puzzle: credit growth in economies with more flexible exchange rate regimes remains tepid well after the capital flow reversal takes place. This results stress the complementarity of macro-prudential policies with the exchange rate regime. More flexible regimes could help smoothing the credit cycle through capital surchages and dynamic provisioning that build buffers to counteract the credit recovery puzzle. In contrast, more rigid exchange rate regimes would benefit the most from measures to contain excessive credit growth during booms, such as reserve requirements, loan-to-income ratios, and debt-to-income and debt-service-to-income limits.

Keywords: Flexible exchange rates, Bank credit, Capital inflows, Capital flows, Economic models, reversals, macro-prudential, exchange rate regimes, exchange rate flexibility, flexible exchange rate regimes, fixed exchange rate, fixed exchange rate regimes, real exchange rate, real effective exchange rate, exchange rate arrangements, rigid exchange rate regimes, exchange rate classification, de facto exchange rate regimes, capital movements, capital flows reversals, inflexible exchange rate regimes, history of exchange rate, exchange rate appreciations, exchange rate management, short-term capital

JEL Classification: F32, F41, E32

Suggested Citation

Magud, Nicolas E. and Vesperoni, Esteban Rodrigo, Exchange Rate Flexibility and Credit During Capital Inflow Reversals: Purgatory…Not Paradise (April 2014). IMF Working Paper No. 14/61, Available at SSRN: https://ssrn.com/abstract=2437296

Nicolas E. Magud (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Esteban Rodrigo Vesperoni

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

University of Maryland, College Park ( email )

College Park, MD 20742
United States

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