Propagation of Speculative Cycles: The Exchange Rate Channel

The nominal and real exchange rates are key relative prices within and between economies. Their volatility and gyrations can have significant cumulative effects on the development pattern of financially integrated economies. The article documents the linkage between global risk aversion and the exchange rate of some developed and developing economy currencies characterised by large short-term interest rate differentials. If capital flows can drive exchange rates and transmit international speculative cycles inside the economic system, a careful design of monetary policy, exchange rate and capital management regimes is a fundamental ingredient of a successful development strategy.