March 2012 issue contents
Is Exchange Rate Stabilization an Appropriate Cure for the Dutch Disease?

by Ruy Lama and Juan Pablo Medina
International Monetary Fund


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