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Exchange rate policy, the real exchange rate, and inflation : lessons from Latin America

  • Kiguel, Miguel A.
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    Exchange rate policy is usually driven by two different, often conflicting, objectives: to support a competitive real exchange rate and to serve as a nominal anchor for low inflation. The author focuses on whether exchange rate policy can affect the real exchange rate in the longer run, and examines the trade-offs that typically arise between real depreciation and inflation. The author argues that exchange rate policy has only a limited ability to achieve durable real depreciation. Devaluations can be effective in the short run, but have a limited impact in the longer run, when the underlying factors affecting demand and the supply of foreign exchange dominate. As a rule of thumb, the author argues that maxi-devaluations are most effective in economies with low and moderate inflation (below twenty percent a year), especially when the underlying causes call for real depreciation. Latin America is a rich laboratory in which to study different exchange rate regimes. The real exchange rate varies over time in countries that have adopted the crawling peg (such as Colombia and Brazil) and in those that use the exchange rate more actively for disinflation. Colombia in the mid-1980s is an example of successful real depreciation. Colombia achieved a 40 percent real depreciation in two years with no significant increase in inflation. This was achieved by avoiding maxi-devaluations and by limiting the size of the desired real depreciation.

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    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 880.

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    Date of creation: 30 Apr 1992
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    Handle: RePEc:wbk:wbrwps:880
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    1. Easterly, William & Schmidt-Hebbel, Klaus, 1991. "The macroeconomics of public sector deficits : a synthesis," Policy Research Working Paper Series 775, The World Bank.
    2. Michael Bruno, 1990. "High Inflation and the Nominal Anchors of an Open Economy," NBER Working Papers 3518, National Bureau of Economic Research, Inc.
    3. Kiguel, Miguel A & Liviatan, Nissan, 1988. "Inflationary Rigidities and Orthodox Stabilization Policies: Lessons from Latin America," World Bank Economic Review, World Bank Group, vol. 2(3), pages 273-98, September.
    4. Rocha, Roberto de Rezende, 1991. "Inflation and stabilization in Yugoslavia," Policy Research Working Paper Series 752, The World Bank.
    5. Kamin, S.B., 1988. "Devaluation, External Balance, And Macroeconomic Performance: A Look At The Numbers," Princeton Studies in International Economics 62, International Economics Section, Departement of Economics Princeton University,.
    6. Kiguel, Miguel A., 1991. "Inflation in Argentina: Stop and go since the Austral plan," World Development, Elsevier, vol. 19(8), pages 969-986, August.
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