Is Exchange Rate Stabilization an Appropriate Cure for the Dutch Disease?
IMF Working Papers, August 1, 2010
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Bibliographic details
- Authors: Juan Pablo Medina Guzman, Ruy Lama
- Published: August 1, 2010
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781455202164.001
Summary
- This paper evaluates how successful is a policy of exchange rate stabilization to counteract the negative effects of a Dutch Disease episode.
- The authors consider a small open economy model that incorporates nominal rigidities and a learning-by-doing externality in the tradable sector.
- Principal conclusion: leaning against an appreciated exchange rate can prevent an inefficient loss of tradable output but at the cost of generating a misallocation of resources in other sectors of the economy.
- The paper also finds that welfare is a decreasing function of exchange rate intervention.
- Policy implication stated: stabilizing the nominal exchange rate in response to a Dutch Disease episode is highly distortionary.
Key Findings
- Exchange rate intervention can prevent inefficient loss of tradable output.
- Exchange rate intervention generates misallocation of resources in non-tradable and other sectors.
- Welfare is a decreasing function of exchange rate intervention, indicating welfare losses with stronger stabilization.
Model and Mechanisms (as described)
- Framework: small open economy model.
- Frictions included: nominal rigidities.
- Externality included: learning-by-doing externality in the tradable sector.
- Trade-off highlighted: preserving tradable output versus distorting resource allocation elsewhere.
Policy Recommendations and Implications
- Exchange rate stabilization as a response to Dutch Disease episodes is not welfare-improving according to the model results.
- Policymakers should account for the distortionary effects and welfare-reducing outcomes when considering nominal exchange rate stabilization to counteract Dutch Disease.