Title Foreign exchange intervention and the Dutch disease / by Julia Faltermeier, Ruy Lama, and Juan Pablo Medina

Published [Washington, D.C.] : International Monetary Fund, [2017] ©2017

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Description 1 online resource (35 pages) Series IMF working paper, 1018-5941 ; WP/17/70 IMF working paper ; WP/17/70. Contents Cover; Contents; 1. Introduction; 2. A Small Open Economy Model; 2.1. Households; 2.2. Wage Setting Process; 2.3. Firms; 2.4. Commodity Sector; 2.5. Monetary Policy and Foreign Exchange Intervention; 2.6. Market Clearing Conditions; 2.7. Calibration; 3. Foreign Exchange Intervention and the Dutch Disease; 3.1. Dutch Disease and Learning-by-Doing Externalities; 3.2. Dutch Disease and Optimal Policy Rules; 3.3. Sensitivity Analysis; 4. Conclusions; References; Appendix: Equilibrium Conditions; Tables; Table 1 Baseline Calibration; Table 2 Welfare Analysis; Figures Figure 1 Commodity Cycle and Foreign Exchange InterventionFigure 2 Effects of Learning-by-Doing; Figure 3 Dutch Disease and Policy Rules; Figure 4 Sensitivity Analysis; Figure 5 Welfare Gains and Sensitivity Analysis Summary We study the optimal foreign exchange (FX) intervention policy in response to a positive terms of trade shock and associated Dutch disease episode in a small open economy model. We find that during a Dutch disease episode tradable production drops below the socially optimal level, resulting in lower welfare under learningby- doing (LBD) externalities. FX reserves accumulation improves welfare by preventing a large appreciation of the real exchange rate and by inducing an efficient reallocation between the tradable and non-tradable sectors. For an empirically plausible parametrization of LBD externalities, the model predicts that in response to a 10 percent increase in commodity prices FX reserves should increase by 1.5 percent of GDP. We also find that the welfare gains from optimally using FX reserves are twice as high as the gains from relying only on monetary policy. These results suggest that FX intervention is a beneficial policy to counteract the loss of competitiveness during a Dutch disease episode Notes Print version record Subject Foreign exchange rates. Foreign exchange rates -- Econometric models Monetary policy -- Econometric models International finance -- Econometric models BUSINESS & ECONOMICS -- Finance. Foreign exchange rates Foreign exchange rates -- Econometric models International finance -- Econometric models Monetary policy -- Econometric models Form Electronic book Author Lama, Ruy, 1975- author. Medina Guzman, Juan Pablo, 1971- author. ISBN 9781475589337 1475589336 ISSN 1018-5941

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