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Prudential Policy for Peggers

  • Stephanie Schmitt-Grohe
  • Martin Uribe

This paper shows that in a small open economy model with downward nominal wage rigidity pegging the nominal exchange rate creates a negative pecuniary externality. This peg-induced externality is shown to cause unemployment, overborrowing, and depressed levels of consumption. The paper characterizes the optimal capital control policy in this model and shows that it is prudential in nature. For it restricts capital inflows in good times and subsidizes external borrowing in bad times. Under plausible calibrations of the model, this type of macro prudential policy is shown to lower the average unemployment rate by 10 percentage points, reduce average external debt by more than 50 percent, and increase welfare by over 7 percent of consumption per period.

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File URL: http://www.nber.org/papers/w18031.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18031.

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Date of creation: May 2012
Date of revision:
Handle: RePEc:nbr:nberwo:18031
Note: EFG IFM ME
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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  1. Luis Felipe Céspedes & Roberto Chang & Diego Saravia, 2010. "Monetary Policy Under Financial Turbulence: an Overview," Working Papers Central Bank of Chile 594, Central Bank of Chile.
  2. Bianchi, Javier, 2009. "Overborrowing and Systemic Externalities in the Business Cycle," MPRA Paper 15114, University Library of Munich, Germany.
  3. Arnaud Costinot & Guido Lorenzoni & Iv�n Werning, 2014. "A Theory of Capital Controls as Dynamic Terms-of-Trade Manipulation," Journal of Political Economy, University of Chicago Press, vol. 122(1), pages 77 - 128.
  4. Roberto Garcia-Saltos & Leonardo Auernheimer, 2000. "International Debt and the Price of Domestic Assets," IMF Working Papers 00/177, International Monetary Fund.
  5. Martín Uribe, 2006. "Individual Versus Aggregate Collateral Constraints and the Overborrowing Syndrome," NBER Working Papers 12260, National Bureau of Economic Research, Inc.
  6. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers 13639, National Bureau of Economic Research, Inc.
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