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Optimal Exchange Rate Policy in a Growing Semi-Open Economy

  • Philippe Bacchetta

    (University of Lausanne and Centre for Economic Policy Research and Hong Kong Institute for Monetary Research)

  • Kenza Benhima

    (University of Lausanne and Centre for Economic Policy Research)

  • Yannick Kalantzis

    (Banque de France)

In this paper, we consider an alternative perspective to China's exchange rate policy. We study a semi-open economy where the private sector has no access to international capital markets but the central bank has full access. Moreover, we assume limited financial development generating a large demand for saving instruments by the private sector. We analyze the optimal exchange rate policy by modelling the central bank as a Ramsey planner. Our 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. We also show 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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Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 092014.

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Length: 36 pages
Date of creation: May 2014
Date of revision:
Handle: RePEc:hkm:wpaper:092014
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  1. Philippe Aghion & Philippe Bacchetta & Romain Ranciere & Kenneth Rogoff, 2006. "Exchange Rate Volatility and Productivity Growth: The Role of Financial Development," NBER Working Papers 12117, National Bureau of Economic Research, Inc.
  2. Kjetil Storesletten & Fabrizio Zilibotti & Zheng Song, 2009. "Growing like China," 2009 Meeting Papers 912, Society for Economic Dynamics.
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  6. Bacchetta, Philippe & Benhima, Kenza & Kalantzis, Yannick, 2012. "Capital Controls with International Reserve Accumulation: Can this Be Optimal?," Working Papers 2012-009, Banco Central de Reserva del Perú.
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  15. Jaewoo Lee & Jonathan David Ostry & Alessandro Prati & Luca Antonio Ricci & Gian-Maria Milesi-Ferretti, 2008. "Exchange Rate Assessments: CGER Methodologies," IMF Occasional Papers 261, International Monetary Fund.
  16. Anton Korinek, 2011. "The New Economics of Prudential Capital Controls: A Research Agenda," IMF Economic Review, Palgrave Macmillan, vol. 59(3), pages 523-561, August.
  17. Korinek, Anton & Serven, Luis, 2010. "Undervaluation through foreign reserve accumulation : static losses, dynamic gains," Policy Research Working Paper Series 5250, The World Bank.
  18. Enrique G. Mendoza & Vincenzo Quadrini & José-Víctor Ríos-Rull, 2009. "Financial Integration, Financial Development, and Global Imbalances," Journal of Political Economy, University of Chicago Press, vol. 117(3), pages 371-416, 06.
  19. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, vol. 80(2), pages 382-88, May.
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