Essays on exchange rate regimes and international financial crises




Hernandez-Verme, Paula Lourdes

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My dissertation examines international monetary arrangements, alternative exchange rate regimes and international financial crises. The first chapter focuses on alternative choices of exchange rate regimes for small open economies subject to financial market frictions. I compare the merits of various inflation stabilization policies implemented in Latin America (particularly Argentina and Perú). The second chapter focuses on financial crises and how they are transmitted under alternative international monetary mechanisms. The third chapter investigates the relative merits of a policy of inflation targeting with floating exchange rates. In the first chapter, I find that under floating exchange rates, the ability to raise domestic inflation above foreign inflation can increase production if credit is rationed. However, there is a limitation on the extent to which inflation can be used to stimulate production: if inflation is increased beyond a threshold level, a reduction in real activity is observed. Under either fixed or floating exchange rate regimes, the consequences of changes in domestic or foreign inflation can differ dramatically, depending on whether or not credit rationing is observed. Finally, instability, indeterminacy of dynamic equilibria and economic fluctuations may arise independently of the exchange rate regime. Private information –coupled with high rates of domestic inflation- increases the scope for indeterminacy and for economic fluctuations. In the second chapter, I find that a common international currency and no legal restrictions on exchange help a financial periphery share reserves with a financial center (which has, relatively, more available reserves), mitigating the output losses due to financial crises. The center has incentives for restrictive rediscounting while the periphery has motives for developing central banking. In the third chapter, I find that under a policy of inflation targeting, steady state equilibria replicate the equilibria under a (free) floating exchange rate regime. The scope for economic fluctuations can be typically reduced by a policy of inflation targeting, when compared to either a (free) floating exchange rate regime or a currency board. However, the potential of this policy to improve on stability and/or on determinacy of dynamic equilibria seems to depend strongly on the probability of repaying loans in the economy.