Devaluations, output and the balance sheet effect: a structural econometric analysis

BIS Working Papers No 215
September 2006

Abstract:

This paper estimates a new open economy macroeconomic model for South Korea to determine the output effect of currency devaluations. Three transmission mechanisms are considered: the expenditure-switching, the balance sheet, and a monetary channel associated to a nominal exchange rate target. Devaluations are defined as an increase in this target. This allows to isolate the effects of an explicit exogenous devaluationary policy shock. Ceteris paribus, a devaluation is found to be expansionary. Output contractions in South Korea should then be associated with a different shock such as an adverse shock on the international interest rate or on export demand.

JEL classification: F31, F41.

Keywords: Devaluations, balance sheet effect, financial accelerator, interest rate rule, exchange rate target, new open economy macroeconomics, structural estimation, DSGE