Working Paper: NBER ID: w13077
Authors: Ricardo J. Caballero; Guido Lorenzoni
Abstract: 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: exchange rate intervention; financial constraints; export sector; optimal policy; overshooting
JEL Codes: E0; E2; F0; F4; H2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial constraints in the export sector (F14) | necessity for intervention (H84) |
| contraction in the export sector during appreciation (F14) | severity of overshooting during depreciation (D25) |
| reduction in consumer demand for nontradables during appreciation (F16) | less destruction in the export sector (F14) |
| less destruction in the export sector (F14) | faster recovery during depreciation (D25) |