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This paper studies the effects of real exchange rate depreciation in an economy with extreme liability dollarization using Vector AutoRegression (VAR) methods. Bolivia's extreme liability dollarization makes it an interesting case for empirical testing of the contractionary-depreciations hypothesis. In contrast to the previous contractionary-depreciations literature, the paper uses identification assumptions which are inspired by modern macroeconomic theory and common in the empirical VAR literature on the effects of monetary policy. The author finds that a real exchange rate depreciation has negligible effects on output, since a contractionary balance-sheet effect on investment is counteracted by the standard expansionary effect on net exports.
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