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Is Exchange Rate Stabilization an Appropriate Cure for the Dutch Disease?

  • Juan Pablo Medina Guzman
  • Ruy Lama

This paper evaluates how successful is a policy of exchange rate stabilization to counteract the negative effects of a Dutch Disease episode. We consider a small open economy model that incorporates nominal rigidities and a learning-by-doing externality in the tradable sector. The paper shows that leaning against an appreciated exchange rate can prevent an inefficient loss of tradable output but at the cost of generating a misallocation of resources in other sectors of the economy. The paper also finds that welfare is a decreasing function of exchange rate intervention. These results suggest that stabilizing the nominal exchange rate in response to a Dutch Disease episode is highly distortionary.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 10/182.

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Length: 43
Date of creation: 01 Aug 2010
Date of revision:
Handle: RePEc:imf:imfwpa:10/182
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  11. R Cooper & Alok Johri, 2000. "Learning by Doing and Aggregate Fluctuations," Department of Economics Working Papers 2000-02, McMaster University.
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  13. Rabanal, Pau & Tuesta, Vicente, 2010. "Euro-dollar real exchange rate dynamics in an estimated two-country model: An assessment," Journal of Economic Dynamics and Control, Elsevier, vol. 34(4), pages 780-797, April.
  14. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
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  18. Baruch Lev & Suresh Radhakrishnan, 2003. "The Measurement of Firm-Specific Organization Capital," NBER Working Papers 9581, National Bureau of Economic Research, Inc.
  19. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, vol. 123(4), pages 1415-1464, November.
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