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)| false Eichengreen B., A. Rose, and C. Wyplosz, 1994, “ Speculative Attacks on Pegged Exchange Rates: An Empirical Exploration with Special Reference to the European Monetary System,” in The New Transatlantic Economy, ed.by ( M. Canzoneri, P. Masson, and V. Grilli Cambridge: Cambridge University Press for CEPR).
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)| false Kaminsky, G., and C. Reinhart, 1996, “ The Twin Crises: The Causes of Banking and Balance of Payments Problems,” International Finance Discussion Paper No. 544, forthcoming in, American Economic Review June 1999( Washington: Board of Governors of the Federal Reserve System).
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The authors would like to thank Shaghil Ahmed, Allan Brunner, John Rogers, Bob Traa, Martin Uribe, and participants at seminars at the Board of Governors of the Federal Reserve System, the Johns Hopkins University, the International Monetary Fund, and at the conferences of the Latin American and Caribbean Economic Association and the Latin American Branch of the Econometric Society for their helpful comments and suggestions.
In fact, their goal is just to explain whether a crisis occurs or not, that is, the variable to be explained is a dummy variable with two values: zero if there is no crisis and one if there is a crisis.
Reserve losses are computed from the month the stock of these reserves held by the central bank peaks until the crisis date. The dual market premium reaches its peak in the month preceeding the crisis date in all cases except for the BB crisis. The symbol “n.a.” indicates nonavailability because of lack of data for the first crisis in 1970 and because the dual market premium does not apply for periods of unified exchange rates.
This panel shows the first principal component of the foreign exchange reserves series of Brazil, Chile, Colombia, Mexico, and Venezuela.
Naturally, common market fundamentals may also lead to comovements of foreign exchange reserves in all these countries. For example, contractionary monetary policies in the center countries will generate capital outflows from emerging markets. In our estimations in Section 4 we control for the effect of common factors.
We will not be able to examine this crisis because our data set starts in January 1970.
Part of the exchange rate pressures led to a sharp increase in the financial market premium, which peaked at 369 percent right before the abandonment of the program.
About $26 billions of foreign capital flowed annually to Latin American countries during 1975-1981.
Interestingly, while dollarization in the past had mainly been a phenomenom driven by changes in the opportunity cost of holding money —with investors replacing peso assets with dollar assets in their portfolios, in the 1980s, dollars started to be used for settling current transactions and as a unit of account.
Inflows to Latin American countries averaged 60 billion dollars a year during that episode (Calvo et al., 1996).
We only examine contagion effects across Latin America because contagion in currency crises has been mostly of a regional nature (see Kaminsky and Reinhart (1999)).
In a pure flexible exchange rate regime, by assumption, the stock of reserves of the central bank drops to zero.
Particularly, Argentina shares important trade relations with the Mercosur countries, making it more likely to lose its competitive edge after, for example, a devaluation in Brazil (see Kaminsky and Reinhart (1999) for an analysis of Mercosur trade links and the odds of crisis in one country in Mercosur when other countries in this free-trade area arrangement suffer foreign exchange market turmoils).
See, Kaminsky and Reinhart (1999) for a detailed analysis of the role of international bank lending in the propagation of crises.
See, Kaminsky, Lyons, and Schmukler (1999) for an analysis of the investment strategies of mutual funds in Latin America.
The model will assume perfect separation of the dual exchange rate markets and a free float of the financial exchange rate even though the central bank of Argentina kept on intervening in capital markets in an attempt to contain the accelerated depreciation of the financial rate. The empirical estimation in section 4 will account for the possibility that the financial exchange rate may not be freely floating.
Note that for estimation purposes, the theoretical model in the dual exchange rate regime was re-written in terms of r (the ratio of foreign exchange reserves to domestic credit in dollars).
Dickey-Fuller tests failed to reject the unit root hypothesis for both the contagion variable and reserves of the central bank of Argentina at the 5 percent significance level. They gave mixed results for the domestic policy variable. The hypothesis was rejected for the U.S. interest rate and the premium.
We allow for interactive dummy variables for the hyperinflation period and for periods in which no stabilization plan was being implemented.
Due to the small number of observations, for the hyperinflation espisode we estimated a VAR(l).
Based on the model’s assumptions, we formulate the US interest rate equation as a univariate AR(3) and include in the reduced-form equation of Latin American countries reserves lags of the US rate in addition to lags of the contagion variable itself.
Recall that in the estimations, we examine the path of reserves as a proportion of domestic credit in U.S. dollars. Hence in these figures reserves are expressed as a percent of domestic credit in US dollars. The responses of the exchange rate premium are expressed in percent. The same holds for Figures 6-12.
The standard deviation of the impulse responses are calculated by 1000 bootstrap replications of the model. The bootstrap procedure uses pseudo-historical data created by drawing with replacement from the empirical distribution of the VAR innovations. All responses are to one unit shocks in the structural innovations of the VAR.
Since Figures 2 and 3 report the responses of foreign exchange reserves as a percentage of domestic credit in U.S. dollars, we multiply these responses by the sample average of the domestic credit series to derive the responses of reserves per se.
The vertical bars in these graphs indicate the crises dates.
We pool together the 1981 and 1982 crises on one hand, and the 1989 and 1990 crises on the other, due to data limitations.
During 1980 alone, the central bank extended loans to financial institutions in trouble amounting to an estimated 5 percent of GDP (See Giorgio and Sagari, 1996). Other estimates indicate that between March and April 1980 alone the central bank increased liquidity by 27 percent of the country’s monetary base to help institutions in trouble (Montanaro, 1990).
The increasing foreign debt, which soared in the early 1980s –by 52 percent in 1979 and 42 percent in 1980– may have also contributed to heighten risk aversion and capital flight (See, Ize and Ortiz (1987) who argue that increasing public debt fuels tax evasion and/or asymmetric risk factors and leads to capital flight). Dornbusch and de Pablo (1989) present evidence of substantial capital flight in that period: external assets of Argentine residents increased by $23.4 billions between 1978 and 1982.
To cope with the internal debt problem, the government re-introduced interest rate controls and fixed the nominal interest rate far below the rate of inflation. While controls were supposed to be of a transitory nature, the regulated segment of the banking sector continued to grow while the free segment gradually faded following the central bank prohibition in August 1983 of new deposits in the un-regulated banking segment.
The crisis corresponding to the collapse of the BB plan is not included in Table 2 due to data limitations arising from the fact that this crisis follows the previous within 8 months only.
In February 1995, the central bank allowed a more flexible use of rediscounts to ease the credit crunch on banks, and this was interpreted as a move away from the convertibility plan (D’Amato et al., 1997). However, the monetary authority ultimately chose to suffer the woes of a recession instead of abandoning the currency board. GDP fell by 4.5 percent and investment by 16 percent in 1995 while the peg of the peso to the dollar survived the crisis.
Bilateral trade links between Argentina and Mexico are basically irrelevant since only 2 percent of Argentina’s exports are destined to Mexico. Third-party trade links are not important either since Argentina’s exports have little in common with Mexican exports.