Abstract
This paper tries to untangle the causes behind the recent real exchange rate overshooting events with particular attention paid to the effects of sudden reversals of capital flows. We examine whether the negative reversals of flows lead to real exchange rate overshooting as Calvo (1999) and others suggest. By utilizing impulse response function and variance decomposition analysis, we argue that there is the asymmetric responses across Sudden Stop and tranquil times. However, this appears to be true in Asia, but not so in Latin America. In Asia, the real exchange rate is driven by supply, demand, and current account shocks in Sudden Stop time, while it is due to monetary and demand shocks in Latin America. The response to monetary shock reveals asymmetric in Latin America while it is not the case in Asia. Furthermore, our result reveals that foreign interest rate contributes more in Latin America than in Asia.
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