Assessing the Impacts and Policy Alternatives
Edited by Gerald A. Epstein and A. Erinc Yeldan
Chapter 2: Real Exchange Rate, Monetary Policy and Employment: Economic Development in a Garden of Forking Paths
Roberto Frenkel and Lance Taylor Dejo a los varios porvenires (no a todos) mi jardín de senderos que se bifurcan. [I am leaving my garden of diverse paths to some (but not all)] Jorge Luis Borges, ‘El jardín de los senderos que se bifurcan’ 2.1 INTRODUCTION The exchange rate affects any economy through many channels. It scales the national price system to the world’s, influences key macro price ratios such as those between tradable and non-tradable goods, capital goods and labor, and even exports and imports (via the costs of intermediate inputs and capital goods, for example). The exchange rate is an asset price, partially determines inflation rates through the cost side and as a monetary transmission vector, and can have significant effects (both short and long run) on effective demand. Correspondingly the exchange rate can be targeted toward many policy objectives. In developing and transition economies five have been of primary importance in recent decades: Resource allocation: through its effects on the price ratios just mentioned, the exchange rate can significantly influence resource allocation, especially if it stays stable in real terms for an extended period of time. Through effects on both resource allocation and aggregate demand, a relatively weak rate can help boost employment, a point of concern in light of stagnant job creation in many developing economies over the past 10–15 years. 2. Economic development: often in conjunction with commercial and industrial policies, the exchange rate can be deployed to 28 1. Real exchange...
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