| Economies of the world are linked more today than perhaps any other time in history. Advancements in technology, increases in capital mobility and the shift of many nations to market oriented economies have been the primary causes. Recent crises in developing regions have reminded us all that many countries are not prepared to handle increased exposure abroad. Therefore, while the long-term benefits of globalization are irrefutable, the short-term costs are often more than a country can bear. More often than not, these costs manifest themselves as speculative pressure on the exchange rate or even an attack of the domestic currency.;This dissertation consists of three chapters illustrating the link between the exchange rate of developing countries and economic fluctuations in foreign countries. Chapter one provides a look at some of the more important economic fundamentals in developing economies. The chapter motivates the empirical analysis which follows. Using the intuition of small open-economy models, I am able to determine exactly how foreign shocks may influence the domestic exchange rate.;In chapter two, I examine, empirically, the impact of competitive price pressure on the domestic equilibrium exchange rate. In general, I find that a devaluation or depreciation in the exchange rate by competitors, leads to exchange rate overvaluation for the domestic economy. This overvaluation must be alleviated by a devaluation of the exchange rate at home, or the country runs the risk of losing exports and deteriorating its current account. Furthermore, large currency overvaluations have been shown in the literature as a predecessor of crisis. When taking neighboring exchange rates into account, my results suggest that East Asian currencies were 2% to 4% more overvalued prior to the crisis than others have previously calculated.;Chapter three focusing on the role capital inflows play on the real exchange rate. It is a well-cited fact that large inflows precipitate real appreciation. It is another well-known fact that inflows to developing countries are typically instigated by external shocks, such as decreasing interest rates in major economies. Using a structural Vector autoregressive (VAR) model, along with data from three countries: Korea, Malaysia, and Mexico, I find significant evidence supporting the above conjectures. The inflows to these countries in the 90's were caused by external shocks. However, the real appreciation was small thanks, in part, to nominal exchange rate pegs during this time. But, the countries are not unscathed. The model still predicts large increases in the money supply instead of real appreciation. |
