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Optimal exchange-rate policy under collateral constraints and wage rigidity

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  • Ottonello, Pablo

Abstract

This paper studies the conduct of monetary policy in economies with currency mismatch. To this end, I build a model that embeds financial frictions from households' collateralized borrowing in foreign currency into an open-economy Keynesian framework. The monetary authority faces a trade-off between traditional unemployment stabilization gains from currency depreciation and its costs in terms of generating debt deflation and tightening households' ability to borrow. The optimal policy under this trade-off results in macroeconomic patterns aligned with those observed in emerging-markets data, including large currency depreciation and consumption adjustments during crises. The optimal degree of “fear of floating” depends on the level of indebtedness with which the economy arrives to a crisis and on the type of experienced by the economy.

Suggested Citation

  • Ottonello, Pablo, 2021. "Optimal exchange-rate policy under collateral constraints and wage rigidity," Journal of International Economics, Elsevier, vol. 131(C).
  • Handle: RePEc:eee:inecon:v:131:y:2021:i:c:s0022199621000556
    DOI: 10.1016/j.jinteco.2021.103478
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    Cited by:

    1. Xing Guo & Pablo Ottonello & Diego J. Perez, 2020. "Monetary Policy and Redistribution in Open Economies," NBER Working Papers 28213, National Bureau of Economic Research, Inc.
    2. Javier Bianchi & Guido Lorenzoni, 2021. "The Prudential Use of Capital Controls and Foreign Currency Reserves," NBER Working Papers 29476, National Bureau of Economic Research, Inc.
    3. Liu, Siming, 2022. "Government spending during sudden stop crises," Journal of International Economics, Elsevier, vol. 135(C).

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    More about this item

    Keywords

    Monetary policy; Exchange rates; Debt deflation; Sudden stops; Currency mismatch; Unemployment;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions

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