The paper investigates the ability of monetary authorities to keep the real exchange rate undervalued over the long run by implementing a policy of accumulating foreign exchange reserves. We consider a model of a three-sector, small, open economy, where the central bank continuously purchases foreign currency reserves and compare the results to Russian and Chinese economies in recent years. Both countries appear to pursue reserve accumulation policies. We find a clear tradeoff between the steady state levels of the real exchange rate and inflation. After calibration, the model predicts an 8.5% real undervaluation of the Russian currency and a 13.7% undervaluation of the Chinese currency. Predicted inflation is found to match observed levels.
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Paper provided by Laboratory for Macroeconomic Analysis in its series Working Papers with number
WP13_2007_17.
Find related papers by JEL classification: E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
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