Exchange Rate Management: Intertemporal Tradeoffs

This 1987 American Economic Review paper by Elhanan Helpman and Assaf Razin shows that managing an exchange rate is never a purely monetary act: it is feasible only together with a monetary-fiscal policy mix that is internally consistent, and once the economy has overlapping generations of finitely-lived individuals (breaking Ricardo-Barro debt neutrality), the precise time pattern of the accompanying tax-and-transfer policy – not just its present value – determines the real consequences. In a freely floating regime, by contrast, monetary injections and withdrawals have no real effects at all. The paper’s central illustration is a disinflation achieved by freezing the exchange rate at an overvalued level while delaying the taxes needed to pay for it: this produces an intergenerational redistribution in which spending rises for generations alive when the policy begins (who capture an unanticipated capital gain on their money holdings) and falls for later generations (who inherit the resulting tax burden), while the government’s external debt rises in every period – a pattern the authors note matches the disinflation experiences of Argentina, Chile, and Israel in the late 1970s and early 1980s.

Assaf Razin | Macro Paper Warehouse

Exchange Rate Management: Intertemporal Tradeoffs