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Optimal Exchange Rate Policy in a Growing Semi-Open Economy

Listed author(s):
  • Philippe Bacchetta
  • Kenza Benhima
  • Yannick Kalantzis

This paper considers an alternative perspective to China’s exchange rate policy. It studies a semi-open economy where the private sector has no access to international capital markets but the central bank has full access. Moreover, it assumes limited financial development generating a large demand for saving instruments by the private sector. The paper analyzes the optimal exchange rate policy by modeling the central bank as a Ramsey planner. Its main result is that in a growth acceleration episode it is optimal to have an initial real depreciation of the currency combined with an accumulation of reserves, which is consistent with the Chinese experience. This depreciation is followed by an appreciation in the long run. The paper also shows that the optimal exchange rate path is close to the one that would result in an economy with full capital mobility and no central bank intervention.

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Article provided by Palgrave Macmillan & International Monetary Fund in its journal IMF Economic Review.

Volume (Year): 62 (2014)
Issue (Month): 1 (April)
Pages: 48-76

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Handle: RePEc:pal:imfecr:v:62:y:2014:i:1:p:48-76
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