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Optimal Exchange Rate Policy and Business Cycles

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  • Cunha, Alexandre B.

Abstract

Implementation and collapse of exchange rate pegging schemes are recurrent events. A currency crisis (pegging) is often followed by an economic downturn (boom). In this essay I study why a benevolent Central Bank should pursue a monetary policy that leads to those recurrent currency crises and subsequent periods of pegging. I show that the optimal policy induces a competitive equilibrium that displays a boom in periods of below average devaluation and a recession in periods of above average devaluation. Therefore, a currency crisis (pegging) can be understood as an optimal policy answer to a recession (boom).
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  • Cunha, Alexandre B., 2002. "Optimal Exchange Rate Policy and Business Cycles," Insper Working Papers wpe_19, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
    • Handle: RePEc:ibm:ibmecp:wpe_19
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    References listed on IDEAS

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    1. Cunha, Alexandre & Araújo, Eurilton, 2014. "Simple Macroeconomic Policies and Welfare: A Quantitative Assessment," Revista Brasileira de Economia - RBE, EPGE Brazilian School of Economics and Finance - FGV EPGE (Brazil), vol. 68(3), September.
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    11. Kiguel, Miguel A & Liviatan, Nissan, 1992. "The Business Cycle Associated.with Exchange Rate-Based Stabilizations," The World Bank Economic Review, World Bank, vol. 6(2), pages 279-305, May.
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    1. Uribe, Martín & Schmitt-Grohé, Stephanie, 2002. "Anticipated Ramsey Reforms and the Uniform Taxation Principle: The Role of International Financial Markets," CEPR Discussion Papers 3438, C.E.P.R. Discussion Papers.

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