Optimal exchange-rate policy under collateral constraints and wage rigidity

Pablo Ottonello

Journal of International Economics, 2021, vol. 131, issue C

Abstract: This paper studies the conduct of monetary policy in economies with currency mismatch. To this end, I build a model that embeds financial frictions from households' collateralized borrowing in foreign currency into an open-economy Keynesian framework. The monetary authority faces a trade-off between traditional unemployment stabilization gains from currency depreciation and its costs in terms of generating debt deflation and tightening households' ability to borrow. The optimal policy under this trade-off results in macroeconomic patterns aligned with those observed in emerging-markets data, including large currency depreciation and consumption adjustments during crises. The optimal degree of “fear of floating” depends on the level of indebtedness with which the economy arrives to a crisis and on the type of experienced by the economy.

Keywords: Monetary policy; Exchange rates; Debt deflation; Sudden stops; Currency mismatch; Unemployment (search for similar items in EconPapers)
JEL-codes: E24 E52 F31 F32 F41 F45 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:131:y:2021:i:c:s0022199621000556

DOI: 10.1016/j.jinteco.2021.103478

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