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Is Exchange Rate Stabilization a+L4510n 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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  1. Stephanie Schmitt-Grohe & Martin Uribe, 2005. "Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model: Expanded Version," NBER Working Papers 11417, National Bureau of Economic Research, Inc.
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