Working Paper: CEPR ID: DP14967
Authors: Elias Albagli; Mauricio Calani; Metodij Hadzivaskov; Mario Marcel; Luca Antonio Ricci
Abstract: Chile offers an example of a country that has overcome the fear of floating by reducing balance sheet mismatches, enhancing financial market development, as well as improving monetary, fiscal, and political institutions, and strengthening policy credibility. Under the floating regime, Chile’s economic adjustment to external shocks appears significantly improved, and its exchange rate pass-through has substantially declined. Our results reinforce the case that moving to a clear and credible floating regime can be associated with a reduction in the fear of floating via economic transformation (like smaller balance sheet mismatches, a larger hedging market, and a lower exchange rate pass-through).
Keywords: exchange rate regime; fx derivatives; hedging; exchange rate passthrough; policy credibility; central bank independence
JEL Codes: E31; E52; F31; F33; F41; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Reduced balance sheet mismatches (F65) | Better economic adjustments to external shocks (F32) |
| Improved institutional credibility (D02) | Lower exchange rate passthrough to domestic prices (F31) |
| Enhanced financial market development (O16) | Better performance in response to external shocks (E32) |
| Floating exchange rate regime (F33) | Decline in exchange rate passthrough to domestic prices (F31) |
| Development of a robust derivatives market (G13) | Facilitation of firms' ability to hedge against currency risks (F31) |
| Floating exchange rate regime (F33) | Reduced balance sheet mismatches (F65) |
| Floating exchange rate regime (F33) | Improved institutional credibility (D02) |
| Floating exchange rate regime (F33) | Enhanced financial market development (O16) |