Devaluation with Exchange rate Floor in a Small Open Economy

David Svacina ()
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David Svacina: Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic

No 2018/06, Working Papers IES from Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies

Abstract: In recent years, central banks in the Czech Republic and Switzerland used exchange rate floor commitment to use unlimited FX interventions to keep the exchange rate above the declared floor rate to persistently devalue their currency and stimulate inflation. Central banks in other small open economies, such as Sweden and Israel, faced similar challenges and could have chosen this instrument as well. In this paper, I develop an extension to dynamic stochastic general equilibrium (DSGE) models that could be used to esimate impact of such devaluations with exchange rate floor. As an illustration, I apply the extension to models estimated for Sweden and the Czech Republic. In particular, I simulate impact of a 5 percent devaluation with the exchange rate floor used as an unconventional monetary policy instrument with interest rates at the zero lower bound. In the first year after the devaluation, the annual consumer price in inflation increases by 0.8 percent in Sweden and 1.8 percent in the Czech Republic. The long-term exchange rate pass-through to consumer prices is 40 percent and 65 percent, respectively. The increase in inflation is highly dependent on the persistent nature of the devaluation.

Keywords: Exchange Rate Floor; Devaluation of Currency; Unconventional Monetary Policy Instrument; Dynamic Stochastic General Equilibrium Models; Exchange Rate Pass-Through (search for similar items in EconPapers)
JEL-codes: E31 E37 E58 F41 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2018-02, Revised 2018-02
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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