TY  - JOUR
AU  - Cespedes,Luis Felipe
AU  - Chang,Roberto
AU  - Velasco,Andres
TI  - Balance Sheets and Exchange Rate Policy
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 7840
PY  - 2000
Y2  - August 2000
UR  - http://www.nber.org/papers/w7840
L1  - http://www.nber.org/papers/w7840.pdf
N1  - Author contact info:
Luis Cespedes
Universidad Adolfo Ibañez
E-Mail: lfcespedes@uai.cl

Roberto Chang
Rutgers University
Department of Economics
75 Hamilton Street
New Brunswick, NJ  08901
Tel: 732/932-7269
Fax: 732/932-7416
E-Mail: chang@econ.rutgers.edu

Andres Velasco
Columbia University
School of International and Public Affairs
420 West 118th Street
New York, NY 10027
Tel: 212/854-3899
E-Mail: avbranes@gmail.com
AB  - We study the relation among exchange rates, balance sheets, and macroeconomic outcomes in a small open economy.  Because liabilities are  dollarized,' a real devaluation has detrimental effects on entreprenurial net worth, which in turn constrains investment due to financial frictions.  But there is an offsetting effect, int hat devaluation expands home output and the return to domestic investment, which are also components of net worth.  We show that the impact of an adverse foreign shock can be strongly magnified by the balance sheet effect of the associated real devaluation.  But the fall in output employment, and investment is stronger under fixed exchange rates than under flexible rates.  Hence the conventional wisdom, that flexible exchange rates are better absorbers of real foreign shocks than are fixed rates, holds in spite of potentially large balance sheet effects.
ER  -