Distributional Effects of Exchange Rate Stabilization in Emerging Markets

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• This paper develops a two-sector, two-agent New-Keynesian model of a small open economy with financial frictions and foreign currency debt in balance sheets. Focusing on an adverse foreign interest rate shock, the distributional consequences of alternative monetary-policy rules are analyzed to account for the exchange-rate stabilization motive in emerging market economies (EMEs). Under an inflation targeting regime, the depreciation of the domestic currency associated with the shock has an expansionary impact on the tradable sector via the expenditure switching channel. However, in the presence of nominal wage rigidities, the ensuing higher inflation associated with the depreciation reduces real wages, which makes households in the non-tradable sector worse off. Partially stabilizing the exchange rate, however, reverses the distributional consequences. Managed exchange rate regimes improve welfare of households in the non-tradable sector at the expense of households in the tradable sector; moreover, these policy regimes can improve aggregate welfare as long as the response to the exchange rate is not too strong. Strongly stabilizing (or fixing) the exchange rate reduces the welfare of both types of households. In an inflation-targeting regime, the use of capital controls or sterilized foreign-exchange interventions is considered as a second instrument. Solving for (Ramsey) optimal policy, we find that capital controls are effective in enhancing macroeconomic stability, while sterilized interventions are nearly ineffective in this environment.

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• Yunsang Kim recently completed a Ph.D. in Economics from Georgetown University in May 2020. He holds a Master of Arts in Business Economics from Wilfrid Laurier University and a Bachelor of Arts in Financial Economics from the University of Western Ontario. His primary fields of research are Macroeconomics, Monetary Policy and International Finance. His current research focuses on understanding the channels through which U.S. monetary policy shocks affect outcomes in emerging market economies (EMEs) and the appropriate policy responses of EMEs to the U.S. monetary spillovers. In his job market paper, Distributional Effects of Exchange Rate

  Stabilization in Emerging Markets, he analyzes the distributional consequences and aggregate welfare implications of alternative monetary policy regimes of EMEs, conditional on U.S. monetary policy shocks, to account for the desirability of exchange rate stabilization in EMEs. His joint work, Did the Unconventional Monetary Policy of the U.S. Hurt Emerging Markets?, develops a two-country model to assess the claims of policy makers in EMEs regarding the adverse effects of capital inflows that resulted from U.S. monetary policy during the Great Recession. This work is forthcoming at Open Economies Review.