Exchange rates

Oleg Itskhoki, Dmitry Mukhin, 17 January 2022

The Mussa puzzle refers to the existence of a large and sudden jump in the volatility of the real exchange rate after the adoption of a floating exchange rate regime in 1973. It is a central piece of evidence in favour of monetary non-neutrality. In contrast to conventional wisdom, this column argues that the puzzle cannot be explained with sticky prices, and instead provides strong evidence in favour of monetary transmission via the financial market. This has important consequences for the design of optimal monetary and exchange rate policy.

John Hooley, Mika Saito, 06 December 2021

During the COVID-19 pandemic, the debate on monetary financing has been reignited and several economists have called for governments to borrow from their central banks to finance larger deficits. This column looks to sub-Saharan Africa, a region where ‘fiscal dominance’ has long been widespread, for useful insights into this debate. It finds that central bank financing of government does have an inflationary impact through the exchange rate channel. Numerical legal limits on central bank financing can be an effective way to mitigate the risks, even if they are not always binding.  

Konstantin Egorov, Dmitry Mukhin, 19 November 2021

Recent evidence shows that most international prices are set in dollars, leading to highly asymmetric spillovers between the US and other economies. This column discusses the normative implications of this fact. The authors argue that inflation targeting is optimal in non-US economies, while the use of capital controls is not. A depreciation of the dollar is unlikely to cause a currency war, but US policy does not fully internalise global spillovers. The US benefits from the dominant status of its currency.      

Georgios Georgiadis, Gernot Müller, Ben Schumann, 17 November 2021

In times of heightened global risk, investors flock to the dollar as their capacity or willingness to bear risk declines. As a result, the dollar appreciates. This column examines the effects of global risk shocks and the dollar’s role in the international adjustment to such shocks, finding that appreciation of the dollar amplifies the adverse effect of global risk shocks considerably. Policies that stabilise the dollar in the face of global risk, such as the liquidity provision by the Federal Reserve in response to the COVID-19 pandemic, can help stabilise global economic activity.

Avinash Persaud, 10 November 2021

John Williamson, one of the icons of international economics, passed away in April 2021. This column outlines some of his many and varied contributions to economic analysis and economic policymaking. In his work on exchange rates, the international monetary system and the challenges of economic crises, transition and development, he was the consummate problem-solver and understood any problem in the round of politics, economics and institutions. 

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