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March 2012 issue
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Coletti, Devereux, Levin, Walsh, Williams
Lama, Medina
Faust
Glocker, Towbin
Bordo, Humpage, Schwartz
King
Ferrucci, Jiménez-Rodriguez, Onorante
Lipínska, Millard
Hamilton
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Is Exchange Rate Stabilization an Appropriate Cure for the Dutch Disease?

by Ruy Lama and Juan Pablo Medina
International Monetary Fund

Abstract

This paper evaluates how successful a policy of exchange rate stabilization is in counteracting the negative effects of a Dutch disease episode. We consider a small open-economy model that incorporates nominal rigidities and a learning-bydoing externality in the tradable sector. The paper shows that leaning against an appreciated exchange rate can prevent an inefficient loss of tradable output but at the cost of generating a misallocation of resources in other sectors of the economy. The paper also finds that welfare is a decreasing function of exchange rate intervention. These results suggest that stabilizing the nominal exchange rate in response to a Dutch disease episode could be highly distortionary.

JEL Codes: E52, F31, F41.

 
Full article (PDF, 42 pages 903 kb)

Discussion by Michael B. Devereux