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Optimal exchange-rate policy under collateral constraints and wage rigidity

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  • Ottonello, Pablo

Abstract

This paper studies the conduct of monetary policy in economies with currency mismatch. To this end, I build a model that embeds financial frictions from households' collateralized borrowing in foreign currency into an open-economy Keynesian framework. The monetary authority faces a trade-off between traditional unemployment stabilization gains from currency depreciation and its costs in terms of generating debt deflation and tightening households' ability to borrow. The optimal policy under this trade-off results in macroeconomic patterns aligned with those observed in emerging-markets data, including large currency depreciation and consumption adjustments during crises. The optimal degree of “fear of floating” depends on the level of indebtedness with which the economy arrives to a crisis and on the type of experienced by the economy.

Suggested Citation

  • Ottonello, Pablo, 2021. "Optimal exchange-rate policy under collateral constraints and wage rigidity," Journal of International Economics, Elsevier, vol. 131(C).
    • Handle: RePEc:eee:inecon:v:131:y:2021:i:c:s0022199621000556
    DOI: 10.1016/j.jinteco.2021.103478
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    Cited by:

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    2. Cavallino, Paolo & Sandri, Damiano, 2023. "The open-economy ELB: Contractionary monetary easing and the trilemma," Journal of International Economics, Elsevier, vol. 140(C).
    3. Lutz, Flora & Zessner-Spitzenberg, Leopold, 2023. "Sudden stops and reserve accumulation in the presence of international liquidity risk," Journal of International Economics, Elsevier, vol. 141(C).
    4. Julien Bengui & Louphou Coulibaly, 2022. "Stagflation and Topsy-Turvy Capital Flows," Staff Working Papers 22-46, Bank of Canada.
    5. Javier Bianchi & Guido Lorenzoni, 2021. "The Prudential Use of Capital Controls and Foreign Currency Reserves," NBER Working Papers 29476, National Bureau of Economic Research, Inc.
    6. Johannes Matschke & Jun Nie, 2022. "Downward Wage Rigidities and Recession Dynamics in Advanced and Emerging Economies," Research Working Paper RWP 22-10, Federal Reserve Bank of Kansas City.
    7. Yildirim, Zekeriya, 2022. "Global financial risk, the risk-taking channel, and monetary policy in emerging markets," Economic Modelling, Elsevier, vol. 116(C).
    8. Javier Bianchi & Louphou Coulibaly, 2023. "A Theory of Fear of Floating," NBER Working Papers 30897, National Bureau of Economic Research, Inc.
    9. Hao Dong & Yingrong Zheng & Na Li, 2023. "Analysis of Systemic Risk Scenarios and Stabilization Effect of Monetary Policy under the COVID-19 Shock and Pharmaceutical Economic Recession," Sustainability, MDPI, vol. 15(1), pages 1-32, January.
    10. Bengui, Julien & Bianchi, Javier, 2022. "Macroprudential policy with leakages," Journal of International Economics, Elsevier, vol. 139(C).
    11. Liu, Siming, 2022. "Government spending during sudden stop crises," Journal of International Economics, Elsevier, vol. 135(C).
    12. Sandri, Damiano & Bergant, Katharina & Grigoli, Francesco & Hansen, Niels-Jakob, 2020. "Dampening Global Financial Shocks: Can Macroprudential Regulation Help (More than Capital Controls)?," CEPR Discussion Papers 14948, C.E.P.R. Discussion Papers.
    13. Masashige Hamano & Francesco Pappadà & Maria Teresa Punzi, 2023. "Optimal Monetary Policy, Tariff Shocks and Exporter Dynamics," Working Papers 2309, Waseda University, Faculty of Political Science and Economics.

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    More about this item

    Keywords

    Monetary policy; Exchange rates; Debt deflation; Sudden stops; Currency mismatch; Unemployment;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions

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