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Volatility and Growth$
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Philippe Aghion and Abhijit Banerjee

Print publication date: 2005

Print ISBN-13: 9780199248612

Published to Oxford Scholarship Online: January 2007

DOI: 10.1093/acprof:oso/9780199248612.001.0001

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Endogenous Volatility in an Open Economy

Endogenous Volatility in an Open Economy

(p.68) 4 Endogenous Volatility in an Open Economy
Volatility and Growth

Phillippe Aghion (Contributor Webpage)

Abhijit Banerjee (Contributor Webpage)

Oxford University Press

This chapter argues that financial liberalization introduces a new problem: Now the real exchange rate, which is the relative price between nontradable and tradable, becomes a source of instability. It goes up in a boom, squeezing profits, which limits borrowing and hence investment and brings the economy down. The fact that the economy is open to capital inflows may actually make things worse, since it allows investment demand to grow very fast in a boom.

Keywords:   real exchange rate, instability, lending boom, capital account liberalization

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