Balance Sheet Effects of a Currency Devaluation: A Stock-Flow Consistent Framework for Mexico

Balance Sheet Effects of a Currency Devaluation: A Stock-Flow Consistent Framework for Mexico

by Lorenzo Nalin and Giuliano Toshiro Yajima
Levy Institute Working paper n.980, December 2020

Abstract
This working paper empirically and theoretically analyzes the exchange rate’s role in Mexico’s
development for the period 2004–19. We test the hypothesis of the re(emergence) of the balance
sheet effect due to an increase in external debt in the nonfinancial corporate sector; higher foreign
debt would affect private investment after episodes of real currency depreciation, in the spirit of the
literature put forward by Gertler, Gilchrist, and Natalucci (2007) and Céspedes, Chang, and Velasco
(2004). We build a stock-flow consistent (SFC) model, following the OPENFLEX model proposed
in Godley and Lavoie (2006), to explore the balance sheet implications from a theoretical
perspective. We simulate the 2014 fall in the Mexican peso generated by the drop in oil prices to
replicate stylized facts for Mexico for the period under investigation. The scenario analysis points to
a hysteresis effect of the real exchange rate (RER) depreciation on investment flows. That is, firms’
investment ratio does not completely recover from negative shocks in the currency.

New paper on Latin America

Lorenzo Nalin and Giuliano Toshiro Yajima (2019) Commodity Speculation and Exchange Rate Swings in Latin America: a Stock Flow Consistent (SFC) Analysis, Working Papers 13/19, Sapienza University of Rome, DISS.

Abstract
We are investigating the role of speculative agents during a commodity-boom period in a small-open, peripheral economy. Latin American countries (LAs) have a long history of speculative attacks, balance of payments crises, and currency devaluations. At the beginning of the 2000s, LAs experienced rising commodity prices and foreign investors shifted part of their portfolio composition towards their securities in search of short-term capital gains. Unlike past episodes, financialization has allowed international investors to have a wider range of financial instruments in which to invest. Apart from the traditional government bonds, new asset categories have appeared such as derivatives, exchange traded funds and structured notes. In order to replicate this macro-financial episode, this work will adopt a Stock Flow Consistent (SFC) framework. International real-financial connections are one of the main issues tackled by this methodology, as put forward in Godley (1999). The element of novelty of our contribution consists in depicting a speculative financial sector, which issues commodity-based assets (CBAs) to be sold to rentier households in the developed country. Comparative static exercises with different scenarios will be performed.

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