Exchange-rate policy in countries with imperfect financial markets when faced with negative balance-of-payments shocks

Abstract:

The paper contains a calibration for a dynamic stochastic general equilibrium model using Russian data. The main objective of the paper is to determine whether the policy of exchange-rate targeting is appropriate when balance-of-payments shocks hit an economy which is characterized by a significant ratio of currency liabilities in the banking system and an increased risk premium. It was found that a floating exchange rate policy leads to a lower decrease of welfare following the shocks than fixed exchange rate policy does. The results can be considered as a theoretical foundation of the inflation targeting and flexible exchange rate policy that are currently in use by the Central Bank of Russia.