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Real Exchange Rate Targeting and Macroeconomic Instability

  • Martin Uribe

Using an optimizing model of a small open economy, this paper studies the macroeconomic effects of PPP rules whereby the government increases the devaluation rate when the real exchange rate defined as the price of tradables in terms of nontradables is below its long-run level and reduces the devaluation rate when the real exchange rate is above its long-run level. The paper shows that the mere existence of such a rule can generate aggregate fluctuations due to self-fulfilling revisions in expectations. The result is shown to obtain in both flexible- and sticky-price environments.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9294.

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Date of creation: Oct 2002
Date of revision:
Publication status: published as Uribe, Martin. "Real Exchange Rate Targeting And Macroeconomic Instability," Journal of International Economics, 2003, v59(1,Jan), 137-159.
Handle: RePEc:nbr:nberwo:9294
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  1. Jonathan David Ostry & Carmen Reinhart, 1991. "Private Saving and Terms of Trade Shocks; Evidence From Developing Countries," IMF Working Papers 91/100, International Monetary Fund.
  2. Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Nominal interest rates, consumption booms, and lack of credibility: A quantitative examination," Journal of Development Economics, Elsevier, vol. 46(2), pages 357-378, April.
  3. Calvo, Guillermo A. & Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Targeting the real exchange rate: theory and evidence," Journal of Development Economics, Elsevier, vol. 47(1), pages 97-133, June.
  4. Martin Uribe, 1995. "Hysteresis in a simple model of currency substitution," International Finance Discussion Papers 509, Board of Governors of the Federal Reserve System (U.S.).
  5. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232.
  6. Rudiger Dornbusch, 1980. "Exchange Rate Rules and Macroeconomic Stability," NBER Working Papers 0473, National Bureau of Economic Research, Inc.
  7. Sergio Rebelo & Carlos A. Vegh, 1995. "Real Effects of Exchange Rate-Based Stabilization: An Analysis of Competing Theories," NBER Working Papers 5197, National Bureau of Economic Research, Inc.
  8. Jose De Gregorio & Peter Wickham & Patricio Arrau & Carmen Reinhart, 1991. "The Demand for Money in Developing Countries; Assessing the Role of Financial innovation," IMF Working Papers 91/45, International Monetary Fund.
  9. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
  10. Reinhart, Carmen & Vegh, Carlos, 1994. "Intertemporal consumption substitution and inflation stabilization:An empirical investigation," MPRA Paper 13427, University Library of Munich, Germany.
  11. Jeffrey A. Frankel & Andrew K. Rose, 1996. "Currency crashes in emerging markets: an empirical treatment," International Finance Discussion Papers 534, Board of Governors of the Federal Reserve System (U.S.).
  12. Giovannini, Alberto, 1985. "Saving and the real interest rate in LDCs," Journal of Development Economics, Elsevier, vol. 18(2-3), pages 197-217, August.
  13. Reinhart, Carmen & Ostry, Jonathan, 1991. "Private Saving and Terms of Trade Shocks," MPRA Paper 13716, University Library of Munich, Germany.
  14. Klein, Michael W. & Marion, Nancy P., 1997. "Explaining the duration of exchange-rate pegs," Journal of Development Economics, Elsevier, vol. 54(2), pages 387-404, December.
  15. Dornbusch, Rudiger, 1982. "PPP Exchange-Rate Rules and Macroeconomic Stability," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 158-65, February.
  16. Mendoza, Enrique G. & Uribe, Martin, 2000. "Devaluation risk and the business-cycle implications of exchange-rate management," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 53(1), pages 239-296, December.
  17. Tjalling C. Koopmans, 1959. "Stationary Ordinal Utility and Impatience," Cowles Foundation Discussion Papers 81, Cowles Foundation for Research in Economics, Yale University.
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