Persistent appreciations and overshooting

Description

Most economies experience episodes of persistent real exchange rate appreciations, when the question arises whether there is a need for intervention to protect the export sector. In this paper we present a model of irreversible destruction where exchange rate intervention may be justified if the export sector is financially constrained. However the criterion for intervention is not whether there are bankruptcies or not, but whether these can cause a large exchange rate overshooting once the factors behind the appreciation subside. The optimal policy includes ex-ante and ex-post interventions. Ex-ante (i.e., during the appreciation phase) interventions have limited effects if the financial resources in the export sector are relatively abundant. In this case the bulk of the intervention takes place ex-post, and is concentrated in the first period of the depreciation phase. In contrast, if the financial constraint in the export sector is tight, the policy is shifted toward ex-ante intervention and it is optimal to lean against the appreciation. On the methodological front, we develop a framework to study optimal dynamic interventions in economies with financially constrained agents. Keywords: Appreciations, overshooting, financial frictions, irreversible investment, pecuniary externality, real wages, optimal policy, exports. JEL Classifications: E0, E2, F0, F4, H2.

Subjects

Series Statement

• Working paper series / Massachusetts Institute of Technology, Dept. of Economics -- working paper 07-13
• Working paper (Massachusetts Institute of Technology. Dept. of Economics) -- no. 07-13.

Links

• http://papers.ssrn.com/sol3/papers.cfm?abstract%5Fid=981909