XXVI Edition

14-15-16 December 2017"

Devaluation with exchange rate floor in a small open economy

Svačina David, Charles University

In recent years, central banks in the Czech Republic and Switzerland have shown that exchange rate floor—commitment to use unlimited FX interventions to keep the exchange rate above the declared floor rate—could be used to persistently devalue the currency. It has, however, not been rigorously shown how this persistent devaluation meets one of its main objectives, increase in consumer prices. I therefore extend the dynamic stochastic general equilibrium (DSGE) methodology such that it could be used to model devaluation with the exchange rate floor, and apply the extension to an existing small open economy model. I then simulate 5 percent devaluation with the exchange rate floor used as an unconventional monetary policy instrument at the zero lower bound. In the first year after the devaluation, the annual consumer price inflation increases by 1.7 percent, and the long-term exchange rate pass-through to consumer prices is 40 percent. The increase in inflation is highly dependent on the persistent nature of the devaluation.

Area: Young Economists Session (YES award)

Keywords: Exchange Rate Floor, Devaluation of Currency, Unconventional Monetary Policy, Dynamic Stochastic General Equilibrium Models, Exchange Rate Pass-Through

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