Working Paper: NBER ID: w1324
Authors: Maurice Obstfeld
Abstract: This paper re-examines the effect of devaluation under capital-account restrictions, adding to traditional formulations the seemingly minor (but realistic) assumption that central-bank reserves earn interest. The extra assumption has important implications. In an intertemporal model, devaluation is no longer neutral in the long run as it is in the literature on the monetary approach to the balance of payments. Further, the economy may possess multiple stationary states, some of them unstable.The analysis confirms, however, that even large devaluations must improve the balance of payments if the economy is initially at a stable stationary position. A by-product of the analysis is a pricing formula for the financial exchange rate in a dual exchange rate system. That formula is consistent with recent consumption-based models of asset pricing.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Devaluation (F31) | Long-run consumption (D15) |
| Devaluation (F31) | Real balances (F31) |
| Devaluation (F31) | Balance of payments (F30) |
| Balance of payments (F30) | National income (P44) |