Optimal Devaluations

According to the conventional wisdom, when an economy enters a recession and nominal prices adjust slowly, the monetary authority should devalue the domestic currency to make the recession less severe. The reason is that a devaluation of the curren...

Full description

Bibliographic Details
Main Authors: Hevia, Constantino, Nicolini, Juan Pablo
Format: Policy Research Working Paper
Language:English
Published: 2012
Subjects:
TAX
Online Access:http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20090511090457
http://hdl.handle.net/10986/4121
id okr-10986-4121
recordtype oai_dc
repository_type Digital Repository
institution_category Foreign Institution
institution Digital Repositories
building World Bank Open Knowledge Repository
collection World Bank
language English
topic ARBITRAGE
ARBITRAGE CONDITION
ARBITRAGE CONDITIONS
ASSET HOLDINGS
BONDS
BUDGET CONSTRAINT
CAPITAL MARKETS
CENTRAL BANK
CLOSED ECONOMY
CONSTANT EXCHANGE RATE
CONSTANT RETURNS TO SCALE
CONSUMERS
CURRENCY MARKET
CURRENCY UNION
CURRENT ACCOUNT
DEBT
DECENTRALIZATION
DEPRECIATION
DEVALUATION
DEVALUATIONS
DEVELOPING COUNTRIES
DISTORTION
DISTORTIONS
DIVIDEND
DIVIDEND TAXES
DIVIDENDS
DOMESTIC BONDS
DOMESTIC CURRENCY
DOMESTIC CURRENCY PRICE
DOMESTIC DEBT
DOMESTIC SECURITIES
ECONOMIC CONDITIONS
ELASTICITY
ELASTICITY OF DEMAND
ELASTICITY OF SUBSTITUTION
EQUATIONS
EQUILIBRIA
EQUILIBRIUM
EQUILIBRIUM CONDITION
EQUILIBRIUM CONDITIONS
EQUILIBRIUM PRICE
EQUILIBRIUM PRICES
EXCHANGE RATE
EXCHANGE RATE DYNAMICS
EXCHANGE RATE FLEXIBILITY
EXCHANGE RATE POLICY
EXCHANGE RATE REGIMES
EXCHANGE RATE VOLATILITY
EXCHANGE RATES
EXOGENOUS SHOCKS
FEDERAL RESERVE
FINANCIAL STUDIES
FISCAL POLICY
FOREIGN ASSETS
FOREIGN CURRENCY
FOREIGN CURRENCY MARKET
FOREIGN DEBT
FOREIGN INTEREST
FOREIGN INTEREST RATE
FOREIGN INVESTORS
GENERAL EQUILIBRIUM
GENERAL EQUILIBRIUM MODEL
GOVERNMENT BUDGET
GOVERNMENT EXPENDITURE
GOVERNMENT EXPENDITURES
GOVERNMENT POLICIES
GOVERNMENT POLICY
GOVERNMENT SPENDING
HOLDING
IMPERFECT SUBSTITUTES
IMPORTS
INCOME
INCOME TAXES
INITIAL DEBT
INSTRUMENT
INTEREST PARITY
INTEREST RATE
INTEREST RATES
INTERNATIONAL BANK
INTERNATIONAL CAPITAL
INTERNATIONAL CAPITAL MARKETS
INTERNATIONAL CAPITAL MOBILITY
INTERNATIONAL CREDIT
INTERNATIONAL ECONOMICS
INTERNATIONAL MACROECONOMICS
INTERNATIONAL MONEY
INTERNATIONAL PRICE
INTERNATIONAL TRADE
LEVY
MACROECONOMICS
MARGINAL COST
MARGINAL UTILITY
MARGINAL UTILITY OF CONSUMPTION
MONETARY AUTHORITY
MONETARY ECONOMICS
MONETARY INSTRUMENTS
MONETARY POLICY
MONEY DEMAND
MONEY SUPPLY
MONOPOLISTIC COMPETITION
MONOPOLY
MULTIPLIERS
NEGATIVE SHOCK
NEGATIVE SHOCKS
NET EXPORTS
NOMINAL DIVIDENDS
NOMINAL EXCHANGE RATE
NOMINAL INTEREST RATE
NOMINAL INTEREST RATES
NOMINAL WAGE
NOMINAL WAGES
OPEN ECONOMIES
OPEN ECONOMY
OPTIMAL ALLOCATION
OPTIMIZATION
OUTPUT
POLICY RESPONSE
POLITICAL ECONOMY
POWER PARITY
PRICE INDEX
PRICE INDEXES
PRICE STABILITY
PRIVATE CONSUMPTION
PRODUCTION FUNCTION
PUBLIC POLICY
PURCHASING POWER
PURCHASING POWER PARITY
REAL EXCHANGE RATE
REAL WAGE
RECESSION
RECESSIONS
RELATIVE PRICE
RELATIVE PRICES
REPUTATION
RESPONSE TO SHOCKS
RETURN
RETURNS
REVALUATION
RISK NEUTRAL
STABILIZATION POLICY
STATE CONTINGENT BONDS
STATE CONTINGENT DEBT
STICKY PRICES
STICKY WAGES
TAX
TAX POLICIES
TAX RATE
TAX RATES
TAXATION
TRADABLE GOOD
TRADABLE GOODS
TRADE BALANCE
TRADE SHOCK
TRADE SHOCKS
TRANSMISSION MECHANISM
UNCERTAINTY
UTILITY FUNCTION
UTILITY MAXIMIZATION
VOLATILITY
WAGES
WEALTH
spellingShingle ARBITRAGE
ARBITRAGE CONDITION
ARBITRAGE CONDITIONS
ASSET HOLDINGS
BONDS
BUDGET CONSTRAINT
CAPITAL MARKETS
CENTRAL BANK
CLOSED ECONOMY
CONSTANT EXCHANGE RATE
CONSTANT RETURNS TO SCALE
CONSUMERS
CURRENCY MARKET
CURRENCY UNION
CURRENT ACCOUNT
DEBT
DECENTRALIZATION
DEPRECIATION
DEVALUATION
DEVALUATIONS
DEVELOPING COUNTRIES
DISTORTION
DISTORTIONS
DIVIDEND
DIVIDEND TAXES
DIVIDENDS
DOMESTIC BONDS
DOMESTIC CURRENCY
DOMESTIC CURRENCY PRICE
DOMESTIC DEBT
DOMESTIC SECURITIES
ECONOMIC CONDITIONS
ELASTICITY
ELASTICITY OF DEMAND
ELASTICITY OF SUBSTITUTION
EQUATIONS
EQUILIBRIA
EQUILIBRIUM
EQUILIBRIUM CONDITION
EQUILIBRIUM CONDITIONS
EQUILIBRIUM PRICE
EQUILIBRIUM PRICES
EXCHANGE RATE
EXCHANGE RATE DYNAMICS
EXCHANGE RATE FLEXIBILITY
EXCHANGE RATE POLICY
EXCHANGE RATE REGIMES
EXCHANGE RATE VOLATILITY
EXCHANGE RATES
EXOGENOUS SHOCKS
FEDERAL RESERVE
FINANCIAL STUDIES
FISCAL POLICY
FOREIGN ASSETS
FOREIGN CURRENCY
FOREIGN CURRENCY MARKET
FOREIGN DEBT
FOREIGN INTEREST
FOREIGN INTEREST RATE
FOREIGN INVESTORS
GENERAL EQUILIBRIUM
GENERAL EQUILIBRIUM MODEL
GOVERNMENT BUDGET
GOVERNMENT EXPENDITURE
GOVERNMENT EXPENDITURES
GOVERNMENT POLICIES
GOVERNMENT POLICY
GOVERNMENT SPENDING
HOLDING
IMPERFECT SUBSTITUTES
IMPORTS
INCOME
INCOME TAXES
INITIAL DEBT
INSTRUMENT
INTEREST PARITY
INTEREST RATE
INTEREST RATES
INTERNATIONAL BANK
INTERNATIONAL CAPITAL
INTERNATIONAL CAPITAL MARKETS
INTERNATIONAL CAPITAL MOBILITY
INTERNATIONAL CREDIT
INTERNATIONAL ECONOMICS
INTERNATIONAL MACROECONOMICS
INTERNATIONAL MONEY
INTERNATIONAL PRICE
INTERNATIONAL TRADE
LEVY
MACROECONOMICS
MARGINAL COST
MARGINAL UTILITY
MARGINAL UTILITY OF CONSUMPTION
MONETARY AUTHORITY
MONETARY ECONOMICS
MONETARY INSTRUMENTS
MONETARY POLICY
MONEY DEMAND
MONEY SUPPLY
MONOPOLISTIC COMPETITION
MONOPOLY
MULTIPLIERS
NEGATIVE SHOCK
NEGATIVE SHOCKS
NET EXPORTS
NOMINAL DIVIDENDS
NOMINAL EXCHANGE RATE
NOMINAL INTEREST RATE
NOMINAL INTEREST RATES
NOMINAL WAGE
NOMINAL WAGES
OPEN ECONOMIES
OPEN ECONOMY
OPTIMAL ALLOCATION
OPTIMIZATION
OUTPUT
POLICY RESPONSE
POLITICAL ECONOMY
POWER PARITY
PRICE INDEX
PRICE INDEXES
PRICE STABILITY
PRIVATE CONSUMPTION
PRODUCTION FUNCTION
PUBLIC POLICY
PURCHASING POWER
PURCHASING POWER PARITY
REAL EXCHANGE RATE
REAL WAGE
RECESSION
RECESSIONS
RELATIVE PRICE
RELATIVE PRICES
REPUTATION
RESPONSE TO SHOCKS
RETURN
RETURNS
REVALUATION
RISK NEUTRAL
STABILIZATION POLICY
STATE CONTINGENT BONDS
STATE CONTINGENT DEBT
STICKY PRICES
STICKY WAGES
TAX
TAX POLICIES
TAX RATE
TAX RATES
TAXATION
TRADABLE GOOD
TRADABLE GOODS
TRADE BALANCE
TRADE SHOCK
TRADE SHOCKS
TRANSMISSION MECHANISM
UNCERTAINTY
UTILITY FUNCTION
UTILITY MAXIMIZATION
VOLATILITY
WAGES
WEALTH
Hevia, Constantino
Nicolini, Juan Pablo
Optimal Devaluations
geographic_facet The World Region
The World Region
relation Policy Research working paper ; no. WPS 4926
description According to the conventional wisdom, when an economy enters a recession and nominal prices adjust slowly, the monetary authority should devalue the domestic currency to make the recession less severe. The reason is that a devaluation of the currency lowers the relative price of non-tradable goods, and this reduces the necessary adjustment in output relative to the case in which the exchange rate remains constant. This paper uses a simple small open economy model with sticky prices to characterize optimal fiscal and monetary policy in response to productivity and terms of trade shocks. Contrary to the conventional wisdom, in this framework optimal exchange rate policy cannot be characterized just by the cyclical properties of output. The source of the shock matters: while recessions induced by a drop in the price of exportable goods call for a devaluation of the currency, those induced by a drop in productivity in the non-tradable sector require a revaluation.
format Publications & Research :: Policy Research Working Paper
author Hevia, Constantino
Nicolini, Juan Pablo
author_facet Hevia, Constantino
Nicolini, Juan Pablo
author_sort Hevia, Constantino
title Optimal Devaluations
title_short Optimal Devaluations
title_full Optimal Devaluations
title_fullStr Optimal Devaluations
title_full_unstemmed Optimal Devaluations
title_sort optimal devaluations
publishDate 2012
url http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20090511090457
http://hdl.handle.net/10986/4121
_version_ 1764390009631145984
spelling okr-10986-41212021-04-23T14:02:15Z Optimal Devaluations Hevia, Constantino Nicolini, Juan Pablo ARBITRAGE ARBITRAGE CONDITION ARBITRAGE CONDITIONS ASSET HOLDINGS BONDS BUDGET CONSTRAINT CAPITAL MARKETS CENTRAL BANK CLOSED ECONOMY CONSTANT EXCHANGE RATE CONSTANT RETURNS TO SCALE CONSUMERS CURRENCY MARKET CURRENCY UNION CURRENT ACCOUNT DEBT DECENTRALIZATION DEPRECIATION DEVALUATION DEVALUATIONS DEVELOPING COUNTRIES DISTORTION DISTORTIONS DIVIDEND DIVIDEND TAXES DIVIDENDS DOMESTIC BONDS DOMESTIC CURRENCY DOMESTIC CURRENCY PRICE DOMESTIC DEBT DOMESTIC SECURITIES ECONOMIC CONDITIONS ELASTICITY ELASTICITY OF DEMAND ELASTICITY OF SUBSTITUTION EQUATIONS EQUILIBRIA EQUILIBRIUM EQUILIBRIUM CONDITION EQUILIBRIUM CONDITIONS EQUILIBRIUM PRICE EQUILIBRIUM PRICES EXCHANGE RATE EXCHANGE RATE DYNAMICS EXCHANGE RATE FLEXIBILITY EXCHANGE RATE POLICY EXCHANGE RATE REGIMES EXCHANGE RATE VOLATILITY EXCHANGE RATES EXOGENOUS SHOCKS FEDERAL RESERVE FINANCIAL STUDIES FISCAL POLICY FOREIGN ASSETS FOREIGN CURRENCY FOREIGN CURRENCY MARKET FOREIGN DEBT FOREIGN INTEREST FOREIGN INTEREST RATE FOREIGN INVESTORS GENERAL EQUILIBRIUM GENERAL EQUILIBRIUM MODEL GOVERNMENT BUDGET GOVERNMENT EXPENDITURE GOVERNMENT EXPENDITURES GOVERNMENT POLICIES GOVERNMENT POLICY GOVERNMENT SPENDING HOLDING IMPERFECT SUBSTITUTES IMPORTS INCOME INCOME TAXES INITIAL DEBT INSTRUMENT INTEREST PARITY INTEREST RATE INTEREST RATES INTERNATIONAL BANK INTERNATIONAL CAPITAL INTERNATIONAL CAPITAL MARKETS INTERNATIONAL CAPITAL MOBILITY INTERNATIONAL CREDIT INTERNATIONAL ECONOMICS INTERNATIONAL MACROECONOMICS INTERNATIONAL MONEY INTERNATIONAL PRICE INTERNATIONAL TRADE LEVY MACROECONOMICS MARGINAL COST MARGINAL UTILITY MARGINAL UTILITY OF CONSUMPTION MONETARY AUTHORITY MONETARY ECONOMICS MONETARY INSTRUMENTS MONETARY POLICY MONEY DEMAND MONEY SUPPLY MONOPOLISTIC COMPETITION MONOPOLY MULTIPLIERS NEGATIVE SHOCK NEGATIVE SHOCKS NET EXPORTS NOMINAL DIVIDENDS NOMINAL EXCHANGE RATE NOMINAL INTEREST RATE NOMINAL INTEREST RATES NOMINAL WAGE NOMINAL WAGES OPEN ECONOMIES OPEN ECONOMY OPTIMAL ALLOCATION OPTIMIZATION OUTPUT POLICY RESPONSE POLITICAL ECONOMY POWER PARITY PRICE INDEX PRICE INDEXES PRICE STABILITY PRIVATE CONSUMPTION PRODUCTION FUNCTION PUBLIC POLICY PURCHASING POWER PURCHASING POWER PARITY REAL EXCHANGE RATE REAL WAGE RECESSION RECESSIONS RELATIVE PRICE RELATIVE PRICES REPUTATION RESPONSE TO SHOCKS RETURN RETURNS REVALUATION RISK NEUTRAL STABILIZATION POLICY STATE CONTINGENT BONDS STATE CONTINGENT DEBT STICKY PRICES STICKY WAGES TAX TAX POLICIES TAX RATE TAX RATES TAXATION TRADABLE GOOD TRADABLE GOODS TRADE BALANCE TRADE SHOCK TRADE SHOCKS TRANSMISSION MECHANISM UNCERTAINTY UTILITY FUNCTION UTILITY MAXIMIZATION VOLATILITY WAGES WEALTH According to the conventional wisdom, when an economy enters a recession and nominal prices adjust slowly, the monetary authority should devalue the domestic currency to make the recession less severe. The reason is that a devaluation of the currency lowers the relative price of non-tradable goods, and this reduces the necessary adjustment in output relative to the case in which the exchange rate remains constant. This paper uses a simple small open economy model with sticky prices to characterize optimal fiscal and monetary policy in response to productivity and terms of trade shocks. Contrary to the conventional wisdom, in this framework optimal exchange rate policy cannot be characterized just by the cyclical properties of output. The source of the shock matters: while recessions induced by a drop in the price of exportable goods call for a devaluation of the currency, those induced by a drop in productivity in the non-tradable sector require a revaluation. 2012-03-19T19:10:21Z 2012-03-19T19:10:21Z 2009-05-01 http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20090511090457 http://hdl.handle.net/10986/4121 English Policy Research working paper ; no. WPS 4926 CC BY 3.0 IGO http://creativecommons.org/licenses/by/3.0/igo/ World Bank Publications & Research :: Policy Research Working Paper The World Region The World Region