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External Shocks and Inflation in Developing Countries Under a Real Exchange Rate Rule

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Author Info

  • Jonathan David Ostry
  • Peter Montiel

Abstract

This paper shows that the response of inflation to external shocks is very different when the authorities target the real exchange rate than when they follow a fixed exchange rate or a preannounced crawling peg. Specifically, shocks that would have no effect on the steady-state inflation rate under a fixed exchange rate are either inflationary or deflationary under a real exchange rate rule. Moreover, irrespective of the degree of capital mobility, the authorities will find it difficult to mitigate the destabilizing effects of real shocks on the price level by using monetary policy, except possibly in the very short run.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 92/75.

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Length: 48
Date of creation: 01 Sep 1992
Date of revision:
Handle: RePEc:imf:imfwpa:92/75

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Related research

Keywords: Exchange rates; Developing countries; Real effective exchange rates; Economic models; exchange rate; inflation; real exchange rate; terms of trade; inflation rate; money supply; price level; rate of inflation; exchange rate rule; exchange rate targeting; foreign exchange; real value; nominal exchange rate; exchange rate target; real money; real interest rate; terms of trade shock; fixed exchange rate; inflation tax; steady-state inflation; real money supply; monetary policy; exchange rate rules; exchange rate targets; fixed nominal exchange rate; increase in inflation; real output; nominal interest rate; real wages; exchange rate policy; official exchange rate; real interest rates; fixed exchange rates; rates of inflation; effective exchange rates; foreign exchange market; real exchange rates; foreign exchange reserves; dual exchange rates; money stock; exchange markets; real variables; high rates of inflation; country exchange rate; inflationary consequences; currency substitution; price inflation; exchange rate dynamics; exchange rate policies; effective exchange rate; effect of inflation; macroeconomic stability; lower inflation; real effective exchange rate; relative price; exchange reserves; rational expectations; foreign exchange transactions; exchange rate management; real exchange rate depreciation; foreign currency; exchange transactions; inflationary impact; exchange rate determination; low levels of inflation; terms of trade shocks; market exchange rate; rise in inflation; exchange rate depreciation; real exchange rate dynamics;

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