## Exchange Rate Policy (ERP)

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### Course description
- Presents a comprehensive overview of exchange rate analysis and policy.
- First part: introduces key definitions and concepts used in exchange rate analysis, including real exchange rate misalignment; discusses how changes in the real exchange rate may affect external adjustment and growth.
- Second part: focuses on macroeconomic volatility and capital flows; analyzes the role of foreign exchange intervention and international reserve adequacy.
- Third part: covers macroeconomic policy tradeoffs under different exchange rate regimes and main exchange rate policy challenges in developing and emerging market economies, including hybrid regimes, forced and unforced exits from pegs, and reasons behind the so-called Fear-of-Floating.
- Fourth part: examines real exchange rate equilibrium and misalignment and elaborates on the External Balance Assessment (EBA) methodology.
- Final part: addresses currency crises and presents an Early Warning System to monitor such events.

### Target audience and prerequisites
- Targeted to (junior to mid-career) officials involved in exchange rate policy and analysis.
- Participants should have an advanced degree in economics or equivalent professional experience.

### Learning objectives
- Compute and interpret indicators of FX reserve adequacy.
- Assess the effectiveness of interventions in the FX market.
- Measure the degree of real exchange rate misalignment.
- Construct early warning systems for currency crises and calculate the probability of experiencing a currency crisis episode.
- Discuss exchange rate policy challenges in emerging and developing economies.
- Identify policy inconsistencies that may lead to currency crises and policy measures to prevent them.

### Topics (course content outline)
1. Basic Principles of Exchange Rate Analysis
   - Key definitions and concepts used in exchange rate analysis (Law of One Price, Purchasing Power Parity, interest parities, nominal and real effective exchange rates).
   - Role of productivity differentials between tradable and non-tradable sectors in explaining variations in the real effective exchange rate (REER).
2. The Role of the Real Exchange Rate
   - REER as an indicator of external competitiveness; REER misalignment.
   - Role played by the exchange rate in external adjustment.
   - Relationship between real exchange rate undervaluation and economic growth.
3. Equilibrium REER and REER misalignment
   - Methodologies to estimate equilibrium real effective exchange rate.
   - IMF External Balance Assessment (EBA) methodology.
4. Exchange Rate Regimes and Macroeconomic Policy
   - Theories involving flexible and fixed exchange rate regimes.
   - Roles of foreign exchange reserves and market interventions under flexible and fixed exchange rate regimes.
   - De jure and de facto classifications of exchange rate regimes.
   - Policy issues involving flexible and fixed exchange rate regimes; the disconnect between theories of exchange rate determination and reality; policy trilemmas and tradeoffs.
5. Practical Problems in Developing and Emerging Market Economies
   - Fear-of-Floating and reasons policymakers dislike large nominal exchange rate changes.
   - Use of hybrid exchange rate regimes; policies to alleviate Fear of Floating.
   - Experiences with forced and un-forced exits from pegs.
6. Exchange Rates and the Foreign Exchange Market
   - Structure of the FX market; objectives and modalities of FX interventions.
   - Costs and benefits of FX reserve accumulation and indicators of FX reserve adequacy.
   - Channels and effectiveness of FX interventions; management of FX reserves; currency trading strategies.
7. Currency Crises
   - Models and cases of currency crises; role of macroeconomic policies in prevention.
   - Early warning systems for currency crises.

### Performance evaluation
- Two multiple-choice tests will be given, one at the beginning and one at the end of the course.
- Performance in these tests will be recorded in participants’ evaluations.

### Course schedule and session structure (selected sessions and durations)
- Introductory Lecture: 1.5 hours (L–1)
  - Introductory Lecture; Structure of the course; Lectures; Workshop
- L–2 Basic Principles of Exchange Rate Analysis: 1.5 hours
  - Key definitions and concepts; Arbitrage, exchange rates, and interest rates; Introduction to the real effective exchange rate (REER)
- L–3 The Role of the Real Exchange Rate: 1.5 hours
  - The exchange rate in internal and external balance; The REER as an indicator of external competitiveness; The relationship between REER and economic growth
  - Lecturer: Mr. Dyna Heng, Economist, Asian Division, IMF Institute for Capacity Development
- L–4 Macroeconomic Volatility and Capital Flows: 1.5 hours
  - Capital flows and macroeconomic activities; Push and pull factors of capital flows; Capital flows, asset prices, and exchange rates
- L–5 FX Interventions: 1.5 hours
  - Sterilized and non-sterilized interventions; Channels and effectiveness of FX interventions; Objectives and modalities of FX interventions
  - Lecturer: Mr. Michael Leahy
- L–6 FX Reserve Adequacy: 1.5 hours
  - Trends in FX reserve accumulation; Indicators of FX reserve adequacy
- W–1 Workshop: FX Reserve Adequacy: 1.5 hours
- L–7 Exchange Rate Regimes: An Overview: 1.5 hours
  - Taxonomy of exchange rate regimes; The trilemma between exchange rate regime, policy independence and capital mobility; History of exchange rate arrangements
- L–8 Exchange Rate Regimes and Macroeconomic Policy: 1.5 hours
  - The exchange rate as nominal anchor; External adjustment and crises; Exchange rates and economic integration
- W–2 Workshop: Choice of the Exchange Rate Regime: 1.5 hours
- L–9 Practical Problems of Exchange Rate Policies in Developing and Emerging Market Economies: 3 hours
  - Fear-of-floating; The use of hybrid exchange rate regimes; Policies to alleviate the fear-of-floating
- W–3 Workshop: Managed Floats: 3 hours
- W–4a Workshop: Policy Responses to External Shocks—case study: 3 hours
- W–4b Workshop: Policy Responses in Selected Developing and Emerging Economies to External Shocks: 1.5 hours
- L–10 Transitions from Fixed to Flexible Exchange Rate Regimes: 1.5 hours
  - Elements for smooth transitions from fixed to flexible regimes; Selected country experiences
- W–5 Workshop: Transitions from Fixed to Flexible Exchange Rate Regimes: 1.5 hours
- L–11 Equilibrium REER and REER Misalignment: 3 hours
  - The exchange rate assessment framework; The EBA (External Balance Assessment) and EBA-lite methodologies; Limitations, extensions, and the role of judgement
- W–6a [P] Workshop on External Balance Assessment (EBA): 1.5 hours
- W–6b [P] Workshop on EBA-Lite: 1.5 hours
- L–12 Currency Crises: 1.5 hours
  - Models of currency crises; Links between currency crises and other types of financial crises; The role of macroeconomic policies in currency crisis prevention
- L–13 Early Warning Systems for Currency Crises: 1.5 hours
  - Building an Early Warning System (EWS); Performance of the EWS; Examples in the literature
- W–7 Workshop: Early Warning Systems for Currency Crises: 3 hours
- Participant activities: Preparations for Participant Presentations; Course Evaluation; Post–Course Quiz; Participant Presentations and Policy Discussion; Closing Session and Presentation of Certificates

### Selected referenced works and authors used in sessions
- Sarno, L., 2008, “Purchasing Power Parity,” in The New Palgrave Dictionary of Economics, 2nd ed.
- Dornbusch, Rudiger, 1980, Open Economy Macroeconomics, Chapter 6.
- Rodrik, Dani, 2008, “The Real Exchange Rate and Economic Growth,” Brookings Papers on Economic Activity, Vol. 39 (Fall), pp. 365-439.
- Dell'Ariccia, Giovanni, Paolo Mauro, Andre Faria, Jonathan David Ostry, Julian Di Giovanni, Martin Schindler, Ayhan Kose, and Marco Terrones, 2008, “Reaping the Benefits of Financial Globalization,” IMF Occasional Papers 264.
- IMF, 2018, “A Decade After the Global Financial Crisis: Are We Safer?” Global Financial Stability Report, October, pp. 1-53.
- Blanchard, Olivier, Gustavo Adler and Irineu de Carvalho Filho, 2015, “Can Foreign Exchange Interventions Stem Exchange Rate Pressures from Global Capital Flow Shocks?” NBER Working Paper No. 21427.
- Ghosh, Atish R., Jonathan D. Ostry, and Marcos Chamon, 2012, “Two Targets, Two Instruments: Monetary and Exchange Rate Policies in Emerging Market Economies,” Staff Discussion Notes No. 12/01.
- International Monetary Fund, 2015, “Assessing Reserve Adequacy – Specific Proposals,” IMF Policy Paper.
- Jeanne, Olivier, and Romain Ranciere, 2011, “The Optimal Level of International Reserves for Emerging Market Countries: A New Formula and Some Applications,” Economic Journal, Vol. 121, Issue 555, pp. 905-930.
- Ghosh, Atish R., Jonathan D. Ostry and C. Tsangarides, 2010, “Exchange Rate Regimes and the Stability of the International Monetary System,” IMF Occasional Paper No. 270.
- Obstfeld, Maurice, Jay Shambaugh, and Alan Taylor, 2005, “The Trilemma in History: Tradeoffs Among Exchange Rates, Monetary Policies, and Capital Mobility,” Review of Economics and Statistics, Vol. 87(3), pp. 423-438.
- Duttagupta, Rupa, Gilda Fernandez, and Cem Karacadag, 2004, “From Fixed to Floats: Operational Aspects of Moving Toward Exchange Rate Flexibility,” IMF Working Paper WP/04/126.
- Phillips, Steven et al., 2013, “The External Balance Assessment (EBA) Methodology,” IMF Working Paper 13/272.
- IMF, 2017, “External Sector Report,” IMF Policy Paper.
- Krugman, Paul R, 1979, “A Model of Balance-of-Payments Crises,” Journal of Money, Credit, and Banking, Vol. 11, pp. 311-325.
- Obstfeld, Maurice, 1996, “Models of Currency Crises with Self-Fulfilling Features,” European Economic Review, Vol. 40, pp. 1037-1047.
- Obstfeld M., J. C. Shambaugh, and A. M. Taylor, 2008, “Financial Stability, The Trilemma and International Reserves,” NBER Working Paper No. 14217.
- Rose A. K., and M.M. Spiegel, 2009, “Cross-country Causes and Consequences of the 2008 Crisis: Early Warning,” NBER Working Paper No. 15357.

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_Source: https://www.imf.org/-/media/files/icd/erp.pdf_