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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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