Exchange Rate Flexibility and Credit During Capital Inflow Reversals: Purgatory…Not Paradise
31 Pages Posted: 15 May 2014
Date Written: April 2014
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: Suggested Citation