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The inflationary consequences of real exchange rate targeting via accumulation of reserves

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  • Kirill Sosunov

    ()
    (State University – Higher School of Economics)

  • Oleg Zamulin

    ()
    (New Economic School)

Abstract

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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Bibliographic Info

Paper provided by Laboratory for Macroeconomic Analysis in its series Working Papers with number WP13_2007_17.

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Length: 32 pages
Date of creation: Jan 2007
Date of revision:
Handle: RePEc:cas:wpaper:wp13_2007_17

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Keywords: Real exchange rate targeting; foreign exchange reserves; Dutch disease.;

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References

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  1. Stockman, Alan C & Tesar, Linda L, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," American Economic Review, American Economic Association, vol. 85(1), pages 168-85, March.
  2. Rudiger Dornbusch, 1980. "Exchange Rate Rules and Macroeconomic Stability," NBER Working Papers 0473, National Bureau of Economic Research, Inc.
  3. Peter Montiel & Jonathan David Ostry, 1991. "Macroeconomic Implications of Real Exchange Rate Targeting in Developing Countries," IMF Working Papers 91/29, International Monetary Fund.
  4. J. Saúl Lizondo, 1991. "Alternative Dual Exchange Market Regimes: Some Steady-State Comparisons," IMF Staff Papers, Palgrave Macmillan, vol. 38(3), pages 560-581, September.
  5. Michael P. Dooley & David Folkerts-Landau & Peter Garber, 2004. "The revived Bretton Woods system," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 9(4), pages 307-313.
  6. Reinhart, Carmen & Calvo, Guillermo & Vegh, Carlos, 1994. "Targeting the real exchange rate: Theory and evidence," MPRA Paper 13412, University Library of Munich, Germany.
  7. Burstein, Ariel & Eichenbaum, Martin & Rebelo, Sergio, 2007. "Modeling exchange rate passthrough after large devaluations," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 346-368, March.
  8. Oomes, Nienke & Ohnsorge, Franziska, 2005. "Money demand and inflation in dollarized economies: The case of Russia," Journal of Comparative Economics, Elsevier, vol. 33(3), pages 462-483, September.
  9. Sachs, J-D & Warner, A-M, 1995. "Natural Resource Abundance and Economic Growth," Papers 517a, Harvard - Institute for International Development.
  10. Franziska Ohnsorge & Nienke Oomes, 2005. "Money Demand and Inflation in Dollarized Economies," IMF Working Papers 05/144, International Monetary Fund.
  11. Ivanova Nadezhda, 2005. "Estimation of own- and cross-price elasticities of disaggregated imported and domestic goods in Russia," EERC Working Paper Series 05-13e, EERC Research Network, Russia and CIS.
  12. Polterovich, Victor & Popov, Vladimir, 2003. "Accumulation of Foreign Exchange Reserves and Long Term Growth," MPRA Paper 20069, University Library of Munich, Germany.
  13. Jeffrey Frankel, 2005. "On the renminbi," CESifo Forum, Ifo Institute for Economic Research at the University of Munich, vol. 6(3), pages 16-21, October.
  14. Rodrik, Dani, 1986. "Disequilibrium exchange rates as industrialization policy," Journal of Development Economics, Elsevier, vol. 23(1), pages 89-106, September.
  15. Dornbusch, Rudiger, 1982. "PPP Exchange-Rate Rules and Macroeconomic Stability," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 158-65, February.
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Cited by:
  1. Polbin, Andrey, 2014. "Econometric estimation of a structural macroeconomic model for the Russian economy," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 3-29.
  2. Kirill Sosunov & Oleg Zamulin, 2006. "Can Oil Prices Explain the Real Appreciation of the Russian Ruble in 1998-2005?," Working Papers w0083, Center for Economic and Financial Research (CEFIR).

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