IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Optimal devaluations

  • Hevia, Constantino
  • Nicolini, Juan Pablo

According to the conventional wisdom, when an economy enters a recession and nominal prices adjust slowly, the monetary authority should devalue the domestic currency to make the recession less severe. The reason is that a devaluation of the currency lowers the relative price of non-tradable goods, and this reduces the necessary adjustment in output relative to the case in which the exchange rate remains constant. This paper uses a simple small open economy model with sticky prices to characterize optimal fiscal and monetary policy in response to productivity and terms of trade shocks. Contrary to the conventional wisdom, in this framework optimal exchange rate policy cannot be characterized just by the cyclical properties of output. The source of the shock matters: while recessions induced by a drop in the price of exportable goods call for a devaluation of the currency, those induced by a drop in productivity in the non-tradable sector require a revaluation.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www-wds.worldbank.org/servlet/WDSContentServer/WDSP/IB/2009/05/11/000158349_20090511090457/Rendered/PDF/WPS4926.pdf
Download Restriction: no

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 4926.

as
in new window

Length:
Date of creation: 01 May 2009
Date of revision:
Handle: RePEc:wbk:wbrwps:4926
Contact details of provider: Postal: 1818 H Street, N.W., Washington, DC 20433
Phone: (202) 477-1234
Web page: http://www.worldbank.org/
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Bianca De Paoli, 2004. "Monetary policy and welfare in a small open economy," LSE Research Online Documents on Economics 19950, London School of Economics and Political Science, LSE Library.
  2. Giancarlo Corsetti & Paolo Pesenti, 2001. "International dimensions of optimal monetary policy," Staff Reports 124, Federal Reserve Bank of New York.
  3. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 743-764, October.
  4. Obstfeld, Maurice & Rogoff, Kenneth, 1999. "New Directions for Stochastic Open Economy Models," Center for International and Development Economics Research, Working Paper Series qt5pf7g8sh, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
  5. Pedro Teles & Isabel Correia & Bernardino Adao, 2007. "On the Relevance of Exchange Rate Regimes for Stabilization Policy," 2007 Meeting Papers 616, Society for Economic Dynamics.
  6. Isabel Correia & Juan Pablo Nicolini & Pedro Teles, 2008. "Optimal fiscal and monetary policy: equivalence results," Staff Report 403, Federal Reserve Bank of Minneapolis.
  7. Lucas, Robert E., 1984. "Money in a theory of finance," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 21(1), pages 9-46, January.
  8. Ferrero, Andrea, 2009. "Fiscal and monetary rules for a currency union," Journal of International Economics, Elsevier, vol. 77(1), pages 1-10, February.
  9. Bernardino Ad�o & Isabel Correia & Pedro Teles, 2003. "Gaps and Triangles," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 699-713.
  10. Ester Faia & Tommaso Monacelli, 2004. "Ramsey Monetary Policy and International Relative Prices," 2004 Meeting Papers 249, Society for Economic Dynamics.
  11. Charles Engel, 2000. "Optimal Exchange Rate Policy:The Influence of Price-Setting and Asset Markets," Working Papers 0020, University of Washington, Department of Economics.
  12. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
  13. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  14. Pedro Teles & Bernardino Adao & Isabel Correia, 2005. "Exchange Rate Regimes," 2005 Meeting Papers 382, Society for Economic Dynamics.
  15. Emmanuel Farhi & Gita Gopinath & Oleg Itskhoki, 2012. "Fiscal devaluations," Working Papers 12-10, Federal Reserve Bank of Boston.
  16. Chari, V.V. & Kehoe, Patrick J., 1999. "Optimal fiscal and monetary policy," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 26, pages 1671-1745 Elsevier.
  17. V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Proceedings, Federal Reserve Bank of Cleveland, pages 519-546.
  18. Robert E. Lucas, Jr. & Nancy L. Stokey, 1985. "Money and Interest in a Cash-in-Advance Economy," NBER Working Papers 1618, National Bureau of Economic Research, Inc.
  19. S. Rao Aiyagari & R. Anton Braun, 1996. "Some explorations into optimal cyclical monetary policy," Working Papers 565, Federal Reserve Bank of Minneapolis.
  20. Hevia, Constantino & Nicolini, Juan Pablo, 2009. "Optimal devaluations," Policy Research Working Paper Series 4926, The World Bank.
  21. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimality of the Friedman Rule in Economies with Distorting Taxes," NBER Working Papers 4443, National Bureau of Economic Research, Inc.
  22. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  23. Faia, Ester & Monacelli, Tommaso, 2006. "Optimal Monetary Policy in a Small Open Economy with Home Bias," CEPR Discussion Papers 5522, C.E.P.R. Discussion Papers.
  24. Maurice Obstfeld & Kenneth Rogoff, 1994. "Exchange Rate Dynamics Redux," NBER Working Papers 4693, National Bureau of Economic Research, Inc.
  25. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky price and limited participation models of money: a comparison," Working Paper Series, Macroeconomic Issues WP-96-28, Federal Reserve Bank of Chicago.
  26. Obstfeld, Maurice & Duarte, Margarida, 2005. "Monetary Policy in the Open Economy Revisited: The Case for Exchange-Rate Flexibility Restored," 2005 Meeting Papers 386, Society for Economic Dynamics.
  27. Ireland, Peter N, 1996. "The Role of Countercyclical Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 704-23, August.
  28. Mccallum, Bennet T., 1988. "Robustness properties of a rule for monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 173-203, January.
  29. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  30. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
  31. Bernheim, B Douglas, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 540-42, August.
  32. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," Econometrica, Econometric Society, vol. 68(5), pages 1151-1180, September.
  33. Bernardino Adao, 2000. "Gaps and Triangles," Econometric Society World Congress 2000 Contributed Papers 1904, Econometric Society.
  34. Raj Chetty & Adam Guren & Day Manoli & Andrea Weber, 2011. "Are Micro and Macro Labor Supply Elasticities Consistent? A Review of Evidence on the Intensive and Extensive Margins," American Economic Review, American Economic Association, vol. 101(3), pages 471-75, May.
  35. Aguiar, Mark & Gopinath, Gita, 2007. "Emerging Market Business Cycles: The Cycle is the Trend," Scholarly Articles 11988098, Harvard University Department of Economics.
  36. Charles T. Carlstrom & Timothy S. Fuerst, 1998. "Price-level and interest-rate targeting in a model with sticky prices," Working Paper 9819, Federal Reserve Bank of Cleveland.
  37. Jordi Gal� & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
  38. Charles T. Carlstrom & Timothy S. Fuerst, 1995. "Interest rate rules vs. money growth rules: a welfare comparison in a cash-in-advance economy," Working Paper 9504, Federal Reserve Bank of Cleveland.
  39. Isabel Correia & Bernardino Adao, 2005. "Optimal Fiscal and Monetary Policy in Open Economies," 2005 Meeting Papers 923, Society for Economic Dynamics.
  40. Diamond, Peter A & Mirrlees, James A, 1971. "Optimal Taxation and Public Production II: Tax Rules," American Economic Review, American Economic Association, vol. 61(3), pages 261-78, June.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:wbk:wbrwps:4926. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Roula I. Yazigi)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.