Optimal Exchange Rate Policy in a Growing Semi-Open Economy

36 Pages Posted: 13 May 2014 Last revised: 29 Jul 2022

Multiple version iconThere are 3 versions of this paper

Date Written: May 13, 2014

Abstract

This working paper was written by Philippe Bacchetta (University of Lausanne and Centre for Economic Policy Research), Kenza Benhima (University of Lausanneand Centre for Economic Policy Research) and Yannick Kalantzis (Banque de France).

In this paper, we consider an alternative perspective to China's exchange rate policy. We study a semi-open economy where the private sector has no access to international capital markets but the central bank has full access. Moreover, we assume limited financial development generating a large demand for saving instruments by the private sector. We analyze the optimal exchange rate policy by modelling the central bank as a Ramsey planner. Our main result is that in a growth acceleration episode it is optimal to have an initial real depreciation of the currency combined with an accumulation of reserves, which is consistent with the Chinese experience. This depreciation is followed by an appreciation in the long run. We also show that the optimal exchange rate path is close to the one that would result in an economy with full capital mobility and no central bank intervention.

JEL Classification: E58, F31, F32, F38

Suggested Citation

Institute for Monetary and Financial Research, Hong Kong, Optimal Exchange Rate Policy in a Growing Semi-Open Economy (May 13, 2014). Swiss Finance Institute Research Paper No. 14-34, Hong Kong Institute for Monetary and Financial Research (HKIMR) Research Paper WP No. 09/2014, Available at SSRN: https://ssrn.com/abstract=2436288 or http://dx.doi.org/10.2139/ssrn.2436288

Hong Kong Institute for Monetary and Financial Research (Contact Author)

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