Persistent appreciations and overshooting: A normative analysis

Ricardo J. Caballero; Guido Lorenzoni

doi:10.1057/imfer.2014.7

Persistent appreciations and overshooting: A normative analysis

Ricardo J. Caballero, Guido Lorenzoni

Research output: Contribution to journal › Article › peer-review

21 Scopus citations

Abstract

Most economies experience episodes of persistent real exchange rate appreciations, when the question arises whether there is a need for intervention to protect the export sector. This paper presents a model of irreversible destruction where exchange rate intervention may be justified if the export sector is financially constrained. However, the criterion for intervention is not whether there are bankruptcies or not, but whether these can cause a large exchange rate overshooting once the factors behind the appreciation subside. The optimal policy includes ex-ante and ex-post interventions. Ex-ante (that is, during the appreciation phase) interventions have limited effects if the financial resources in the export sector are relatively abundant. In this case the bulk of the intervention takes place ex-post, and is concentrated in the first period of the depreciation phase. In contrast, if the financial constraint in the export sector is tight, the policy is shifted toward ex-ante intervention and it is optimal to lean against the appreciation.

Original language	English (US)
Pages (from-to)	1-47
Number of pages	47
Journal	IMF Economic Review
Volume	62
Issue number	1
DOIs	https://doi.org/10.1057/imfer.2014.7
State	Published - Apr 2014

Funding

*Ricardo J. Caballero is the Ford International Professor of Economics at the Massachusetts Institute of Technology. Guido Lorenzoni is Professor of Economics at Northwestern University. The authors are grateful to Manuel Amador, Gita Gopinath, Arvind Krishnamurthy, Pablo Kurlat, Enrique Mendoza, Klaus Schmidt-Hebbel, Carlos Végh and seminar participants at Berkeley, Harvard, IMF, MIT, IFM-NBER, WEL-MIT, the World Bank, San Francisco Federal Reserve, LACEA-Central Bank of Chile, Paris School of Economics, SED Meeting (Prague), EUI, Santa Cruz Conference on International Economics, University of Chicago for their comments, and to Nicolas Arregui, Jose Tessada, Lucia Tian, and, especially, Pablo Kurlat for excellent research assistance. Caballero thanks the NSF for financial support.

ASJC Scopus subject areas

General Economics, Econometrics and Finance
General Business, Management and Accounting

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title = "Persistent appreciations and overshooting: A normative analysis",

abstract = "Most economies experience episodes of persistent real exchange rate appreciations, when the question arises whether there is a need for intervention to protect the export sector. This paper presents a model of irreversible destruction where exchange rate intervention may be justified if the export sector is financially constrained. However, the criterion for intervention is not whether there are bankruptcies or not, but whether these can cause a large exchange rate overshooting once the factors behind the appreciation subside. The optimal policy includes ex-ante and ex-post interventions. Ex-ante (that is, during the appreciation phase) interventions have limited effects if the financial resources in the export sector are relatively abundant. In this case the bulk of the intervention takes place ex-post, and is concentrated in the first period of the depreciation phase. In contrast, if the financial constraint in the export sector is tight, the policy is shifted toward ex-ante intervention and it is optimal to lean against the appreciation.",

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Persistent appreciations and overshooting: A normative analysis

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