Working Paper: CEPR ID: DP9666
Authors: Philippe Bacchetta; Kenza Benhima; Yannick Kalantzis
Abstract: 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.
Keywords: China; Exchange Rate Policy; International Reserves
JEL Codes: E58; F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| initial real depreciation of the currency (F31) | increased saving (D14) |
| increased saving (D14) | long-term appreciation of the currency (F31) |
| initial real depreciation of the currency (F31) | long-term appreciation of the currency (F31) |