Working Paper: NBER ID: w9294
Authors: Martn Uribe
Abstract: Using an optimizing model of a small open economy, this paper studies the macroeconomic effects of PPP rules whereby the government increases the devaluation rate when the real exchange rate defined as the price of tradables in terms of nontradables is below its long-run level and reduces the devaluation rate when the real exchange rate is above its long-run level. The paper shows that the mere existence of such a rule can generate aggregate fluctuations due to self-fulfilling revisions in expectations. The result is shown to obtain in both flexible- and sticky-price environments.
Keywords: No keywords provided
JEL Codes: F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| PPP rules (D72) | indeterminacy in rational expectations equilibrium (D84) |
| indeterminacy in rational expectations equilibrium (D84) | endogenous fluctuations in the economy (E32) |
| real exchange rate below long-run level (F31) | increase in devaluation rate (F31) |
| increase in devaluation rate (F31) | anticipated future devaluations (F31) |
| anticipated future devaluations (F31) | current real exchange rate depreciation (F31) |
| anticipated future devaluations (F31) | increase in nominal interest rate (E43) |
| increase in nominal interest rate (E43) | reduction in demand for real money balances (E41) |
| reduction in demand for real money balances (E41) | decrease in current consumption (E21) |
| decrease in current consumption (E21) | pressure on relative price of nontradables (F16) |
| pressure on relative price of nontradables (F16) | real depreciation (F31) |