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Is Exchange Rate Stabilization an Appropriate Cure for the Dutch Disease?

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  • Ruy Lama

    (International Monetary Fund)

  • Juan Pablo Medina

    (International Monetary Fund)

Abstract

This paper evaluates how successful a policy of exchange rate stabilization is in counteracting the negative effects of a Dutch disease episode. We consider a small open-economy model that incorporates nominal rigidities and a learning-bydoing externality in the tradable sector. The paper shows that leaning against an appreciated exchange rate can prevent an inefficient loss of tradable output but at the cost of generating a misallocation of resources in other sectors of the economy. The paper also finds that welfare is a decreasing function of exchange rate intervention. These results suggest that stabilizing the nominal exchange rate in response to a Dutch disease episode could be highly distortionary.

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Bibliographic Info

Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 8 (2012)
Issue (Month): 1 (March)
Pages: 5-46

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Handle: RePEc:ijc:ijcjou:y:2012:q:1:a:1

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References

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  1. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May.
  2. Alejandro Justiniano & Bruce Preston, 2008. "Can Structural Small Open Economy Models Account for the Influence of Foreign Disturbances?," NBER Working Papers 14547, National Bureau of Economic Research, Inc.
  3. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
  4. Andrew Clarke, 2008. "Learning-by-Doing and Productivity Dynamics in Manufacturing Industries," Department of Economics - Working Papers Series 1032, The University of Melbourne.
  5. Stephen Murchison & Andrew Rennison, 2006. "ToTEM: The Bank of Canada's New Quarterly Projection Model," Technical Reports 97, Bank of Canada.
  6. Carlos de Resende & Ali Dib & Maral Kichian, 2010. "Alternative Optimized Monetary Policy Rules in Multi-Sector Small Open Economies: The Role of Real Rigidities," Working Papers 10-9, Bank of Canada.
  7. Aasim M. Husain & Ashoka Mody & Nienke Oomes & Robin Brooks & Kenneth Rogoff, 2003. "Evolution and Performance of Exchange Rate Regimes," IMF Working Papers 03/243, International Monetary Fund.
  8. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, vol. 123(4), pages 1415-1464, November.
  9. Cooper, Russell & Johri, Alok, 2002. "Learning-by-doing and aggregate fluctuations," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1539-1566, November.
  10. Krugman, Paul, 1987. "The narrow moving band, the Dutch disease, and the competitive consequences of Mrs. Thatcher : Notes on trade in the presence of dynamic scale economies," Journal of Development Economics, Elsevier, vol. 27(1-2), pages 41-55, October.
  11. Rabanal, Pau & Tuesta, Vicente, 2010. "Euro-dollar real exchange rate dynamics in an estimated two-country model: An assessment," Journal of Economic Dynamics and Control, Elsevier, vol. 34(4), pages 780-797, April.
  12. Juan Pablo Medina & Claudio Soto, 2007. "Copper Price, Fiscal Policu and Business Cycle in Chile," Working Papers Central Bank of Chile 458, Central Bank of Chile.
  13. Chen, Yu-chin & Rogoff, Kenneth, 2003. "Commodity currencies," Journal of International Economics, Elsevier, vol. 60(1), pages 133-160, May.
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Citations

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Cited by:
  1. Isaac Gross & James Hansen, 2013. "Reserves of Natural Resources in a Small Open Economy," RBA Research Discussion Papers rdp2013-14, Reserve Bank of Australia.
  2. Jair N. OJeda & Julián A. Parra Polanía & Carmiña O. Vargas, 2014. "Natural-Resource Booms, Fiscal Rules and Welfare in a Small Open Economy," Borradores de Economia 807, Banco de la Republica de Colombia.
  3. Mohamed Tahar Benkhodja, 2011. "Monetary Policy and the Dutch Disease in a Small Open Oil Exporting Economy," Working Papers 1134, Groupe d'Analyse et de Théorie Economique (GATE), Centre national de la recherche scientifique (CNRS), Université Lyon 2, Ecole Normale Supérieure.
  4. Ruslan Aliyev, 2012. "Monetary Policy in Resource-Rich Developing Economies," CERGE-EI Working Papers wp466, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  5. Hilde C. Bjørnland & Leif Anders Thorsrud, 2013. "Boom or gloom? Examining the Dutch disease in a two-speed economy," CAMA Working Papers 2013-76, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  6. José De Gregorio & Felipe Labbé, 2011. "Copper, the Real Exchange Rate and Macroeconomic Fluctuations in Chile," Working Papers Central Bank of Chile 640, Central Bank of Chile.
  7. Orrego, Fabrizio & Vega, Germán, 2013. "Dutch disease and fiscal policy," Working Papers 2013-021, Banco Central de Reserva del Perú.
  8. Hernando Vargas Herrera & Andrés González & Diego Rodríguez, 2013. "Foreign Exchange Intervention in Colombia," Borradores de Economia 757, Banco de la Republica de Colombia.
  9. Enzo Cassino & David Oxley, 2013. "How Does the Exchange Rate Affect the Real Economy? A Literature Survey," Treasury Working Paper Series 13/26, New Zealand Treasury.
  10. Cherif, Reda, 2013. "The Dutch disease and the technological gap," Journal of Development Economics, Elsevier, vol. 101(C), pages 248-255.
  11. Nicolás Magud & Sebastián Sosa, 2013. "When And Why Worry About Real Exchange Rate Appreciation? The Missing Link Between Dutch Disease And Growth," Journal of International Commerce, Economics and Policy (JICEP), World Scientific Publishing Co. Pte. Ltd., vol. 4(02), pages 1350009-1-1.
  12. Ragna Alstadheim & Hilde C. Bjørnland & Junior Maih, 2013. "Do Central Banks Respond to Exchange Rate Movements? A Markow-Switching Structural Investigation," Working Papers 0018, Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School.

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