We consider an economy under a fixed exchange rate system, but with bounds (a
minimum level or a band) on the real exchange rate. The international price of the
tradable good is characterized by the continuous arrival of shocks that change its level.
In a model with microfoundations, we investigate the effects of targeting the real
exchange rate through nominal exchange rate changes that preclude the real exchange
from trespassing the imposed bounds.
A stochastic general model with two goods and fixed non-tradable goods price level is
developed. We analyze the cases in which a lower bound or a band on the real exchange
rate is introduced. The general conclusion is that when bounds are established, then
welfare effects can be expected, which are generated at the expense of the levels of
consumption that go in the opposite direction than what policy intended. This short-run
effect is present even in the case the targeting policy is never exercised. This result is
similar to the one we find in the target zones literature, in the sense that just the existence of this tolerance band changes the behavior of the economy.
An interesting result is that, in the case in which home goods prices are fixed, the
imposition of the band on the real exchange rate does not change its behavior within the
band. However, this result is not true of other real variables in the economy. In other
words, although the targeted variable within the band behaves identically to the case in
which there are no bounds, the rest of the real variables in the economy behave
differently, even if the targeted variable remains within the band and the escape clause is
not triggered.
| Identifer | oai:union.ndltd.org:tamu.edu/oai:repository.tamu.edu:1969.1/3916 |
| Date | 16 August 2006 |
| Creators | Gonzalez, Pablo |
| Contributors | Auernheimer, Leonardo |
| Publisher | Texas A&M University |
| Source Sets | Texas A and M University |
| Language | en_US |
| Detected Language | English |
| Type | Book, Thesis, Electronic Dissertation, text |
| Format | 741259 bytes, electronic, application/pdf, born digital |
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