## Foreign Exchange Intervention and the Dutch Disease

_IMF Working Papers, March 27, 2017_

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## Bibliographic details
- Authors: Julia Faltermeier, Ruy Lama, Juan Pablo Medina
- Published: March 27, 2017
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475589238.001

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### Research question and model
- Studies the optimal foreign exchange (FX) intervention policy in response to a positive terms of trade shock and associated Dutch disease episode in a small open economy model.
- Incorporates learning-by-doing (LBD) externalities to assess social optimality of production allocations.

### Key findings
- During a Dutch disease episode tradable production drops below the socially optimal level, resulting in lower welfare under learning-by-doing (LBD) externalities.
- FX reserves accumulation improves welfare by:
  - preventing a large appreciation of the real exchange rate, and
  - inducing an efficient reallocation between the tradable and non-tradable sectors.
- For an empirically plausible parametrization of LBD externalities, the model predicts that in response to a 10 percent increase in commodity prices FX reserves should increase by 1.5 percent of GDP.
- The welfare gains from optimally using FX reserves are twice as high as the gains from relying only on monetary policy.

### Policy implications
- FX intervention is a beneficial policy to counteract the loss of competitiveness during a Dutch disease episode.
- Optimal FX reserves accumulation can be more effective than monetary policy alone in preserving tradable-sector activity and overall welfare.

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_Source: https://www.imf.org/en/publications/wp/issues/2017/03/27/foreign-exchange-intervention-and-the-dutch-disease-44767_