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Explaining the Real Exchange Rate During Sudden Stops Period: Evidence from Asia and Latin America

This paper tries to untangle the causes behind the recent real exchange rate overshooting events with particular attention paid to the Sudden Stop of capital flows, and also to the comparison across the two emerging markets, Asian and Latin America. We examine whether the sudden stop of capital inflows leads to asymmetric behavior in real exchange rate movements as suggested by Calvo (1999) among others. By utilizing cumulative impulse response function and variance decomposition analysis, we argue that there is the asymmetric response across Sudden Stop and tranquil times. Further comparison across Asia and Latin America, however, reveals that the sudden stop disturbance has significantly larger explanatory power in Asia than in Latin America. The estimation result also reveals that the real exchange rate in Asia is subject more to the external shocks while it is due more to the domestic policy developments in Latin America. I thank Graciela Kaminsky, Holger Wolf, and the participants at the LAEBA conferences in September 2003, Tokyo Japan, and October 2003, Puebla, Mexico.