{
  "title": "Optimal Exchange Rate Policy with Oil Shocks",
  "publication": "IMF Working Papers, February 20, 2026",
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  "summary": "We study optimal monetary and exchange rate policy in a small open economy facing oil price shocks. In a model with segmented financial markets that generate endogenous UIP deviations, the first-best allocation is achieved through a combination of interest rate policy and foreign exchange interventi",
  "sections": [
    {
      "heading": "Abstract and central mechanism",
      "content": "- Study of optimal monetary and exchange rate policy in a small open economy facing oil price shocks.\n- Model features segmented financial markets that generate endogenous UIP deviations.\n- First-best allocation is achieved through a combination of interest rate policy and foreign exchange intervention (FXI).\n- Monetary policy role: stabilize domestic inflation and the output gap.\n- FXI role: target the UIP wedge to offset financial frictions.\n- Key mechanism: oil price shocks endogenously move the net foreign asset position, creating financial imbalances that make FXI essential — distinct from the exogenous financial shocks emphasized in the literature.\n- FXI breaks the destabilizing link between real commodity shocks and financial risk premia."
    },
    {
      "heading": "Quantitative findings and welfare implications",
      "content": "- Calibration: a calibrated oil exporter is used for quantitative evaluation.\n- Welfare losses under suboptimal regimes:\n  - Suboptimal regimes such as a free float or a simple peg entail sizable welfare losses of around 2% in consumption-equivalent terms.\n  - Peg, and especially peg with fuel subsidies, can outperform free floats in the calibrated setting."
    },
    {
      "heading": "Policy prescriptions and comparative regimes",
      "content": "- Optimal policy package:\n  - Use interest rate policy to stabilize domestic inflation and the output gap.\n  - Use FXI to target and offset endogenous UIP wedges generated by segmented financial markets.\n- Policy implication: FXI is crucial when real commodity (oil) shocks transmit to financial risk premia via changes in net foreign asset positions.\n- Comparison of regimes:\n  - Free float: associated with sizable welfare loss (around 2% consumption-equivalent).\n  - Simple peg: also entails sizable welfare loss, but can outperform free float in some cases.\n  - Peg with fuel subsidies: can perform especially well relative to free float in the calibrated oil exporter.\n\n---\n\n Content in this bundle\n\n- Working Paper\n  - Working Paper (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - Working Paper (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2026/02/19/optimal-exchange-rate-policy-with-oil-shocks-572706"
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    "Authors: Emrehan Aktuğ, Abolfazl Rezghi",
    "Published: February 20, 2026",
    "Series: IMF Working Papers",
    "DOI: https://doi.org/10.5089/9798229033220.001",
    "Study of optimal monetary and exchange rate policy in a small open economy facing oil price shocks.",
    "Model features segmented financial markets that generate endogenous UIP deviations.",
    "First-best allocation is achieved through a combination of interest rate policy and foreign exchange intervention (FXI).",
    "Monetary policy role: stabilize domestic inflation and the output gap.",
    "FXI role: target the UIP wedge to offset financial frictions.",
    "Key mechanism: oil price shocks endogenously move the net foreign asset position, creating financial imbalances that make FXI essential — distinct from the exogenous financial shocks emphasized in the literature.",
    "FXI breaks the destabilizing link between real commodity shocks and financial risk premia.",
    "Calibration: a calibrated oil exporter is used for quantitative evaluation.",
    "Welfare losses under suboptimal regimes:",
    "Optimal policy package:",
    "Policy implication: FXI is crucial when real commodity (oil) shocks transmit to financial risk premia via changes in net foreign asset positions.",
    "Comparison of regimes:",
    "**Working Paper**"
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