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Exchange rate policy, the real exchange rate, and inflation : lessons from Latin America

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  • Kiguel, Miguel A.

Abstract

Exchange rate policy is usually driven by two different, often conflicting, objectives: to support a competitive real exchange rate and to serve as a nominal anchor for low inflation. The author focuses on whether exchange rate policy can affect the real exchange rate in the longer run, and examines the trade-offs that typically arise between real depreciation and inflation. The author argues that exchange rate policy has only a limited ability to achieve durable real depreciation. Devaluations can be effective in the short run, but have a limited impact in the longer run, when the underlying factors affecting demand and the supply of foreign exchange dominate. As a rule of thumb, the author argues that maxi-devaluations are most effective in economies with low and moderate inflation (below twenty percent a year), especially when the underlying causes call for real depreciation. Latin America is a rich laboratory in which to study different exchange rate regimes. The real exchange rate varies over time in countries that have adopted the crawling peg (such as Colombia and Brazil) and in those that use the exchange rate more actively for disinflation. Colombia in the mid-1980s is an example of successful real depreciation. Colombia achieved a 40 percent real depreciation in two years with no significant increase in inflation. This was achieved by avoiding maxi-devaluations and by limiting the size of the desired real depreciation.

Suggested Citation

  • Kiguel, Miguel A., 1992. "Exchange rate policy, the real exchange rate, and inflation : lessons from Latin America," Policy Research Working Paper Series 880, The World Bank.
  • Handle: RePEc:wbk:wbrwps:880
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    References listed on IDEAS

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    5. Kamin, S.B., 1988. "Devaluation, External Balance, And Macroeconomic Performance: A Look At The Numbers," Princeton Studies in International Economics 62, International Economics Section, Departement of Economics Princeton University,.
    6. Kiguel, Miguel A & Liviatan, Nissan, 1988. "Inflationary Rigidities and Orthodox Stabilization Policies: Lessons from Latin America," The World Bank Economic Review, World Bank, vol. 2(3), pages 273-298, September.
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    Cited by:

    1. Daniel Aromi & Marcos Dal Bianco, 2014. "Un analisis de los desequilibrios del tipo de cambio real argentino bajo cambios de regimen," Working Papers 1431, BBVA Bank, Economic Research Department.
    2. Kamin, Steve B. & Rogers, John H., 2000. "Output and the real exchange rate in developing countries: an application to Mexico," Journal of Development Economics, Elsevier, vol. 61(1), pages 85-109, February.
    3. Steven B. Kamin, 1998. "A multi-country comparison of the linkages between inflation and exchange rate competitiveness," International Finance Discussion Papers 603, Board of Governors of the Federal Reserve System (U.S.).
    4. M. O. Odedokun, 1997. "An empirical analysis on the determinants of the real exchange rate in African countries," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 6(1), pages 63-82.
    5. Ndung'u, N.S., 1999. "Monetary and Exchange Rate Policy in Kenya," Papers 94, African Economic Research Consortium.
    6. Steven B. Kamin & Marc Klau, 2003. "A multi-country comparison of the linkages between inflation and exchange rate competitiveness," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 8(2), pages 167-184.
    7. Steven B. Kamin, 1997. "A multi-country comparison of the linkages between inflation and exchange rate competitiveness," BIS Working Papers 45, Bank for International Settlements.

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