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Prudential Policy for Peggers

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  • Stephanie Schmitt-Grohe
  • Martin Uribe

Abstract

This paper shows that in a small open economy model with downward nominal wage rigidity pegging the nominal exchange rate creates a negative pecuniary externality. This peg-induced externality is shown to cause unemployment, overborrowing, and depressed levels of consumption. The paper characterizes the optimal capital control policy in this model and shows that it is prudential in nature. For it restricts capital inflows in good times and subsidizes external borrowing in bad times. Under plausible calibrations of the model, this type of macro prudential policy is shown to lower the average unemployment rate by 10 percentage points, reduce average external debt by more than 50 percent, and increase welfare by over 7 percent of consumption per period.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18031.

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Date of creation: May 2012
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Handle: RePEc:nbr:nberwo:18031

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Cited by:
  1. Olivier Jeanne, 2014. "Macroprudential Policies in a Global Perspective," NBER Working Papers 19967, National Bureau of Economic Research, Inc.
  2. Gianluca Benigno & Luca Fornaro, 2014. "The Financial Resource Curse," Scandinavian Journal of Economics, Wiley Blackwell, vol. 116(1), pages 58-86, 01.

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