Research

We characterize jointly optimal exchange rate and monetary policies under commitment in a heterogeneous-agent, import-dependent small open economy facing essential import price spikes. When some households are borrowing constrained, exchange rate management becomes a tool for real income stabilization through the intertemporal margin, requiring temporary interest parity deviations, while optimal monetary policy targets the labor wedge. In an open economy, these roles are not substitutable. A Ramsey planner internalizes how pecuniary general equilibrium effects from real exchange rate movements redistribute real incomes: facing a spike, the planner leans against the depreciation, cutting exports and shifting resources toward constrained households through higher real wages. Calibrated to Japan`s 2022 energy price path, optimal policy departs from representative-agent prescriptions and uses FX interventions to cut the contemporaneous co-movement of the real exchange rate with world energy prices while accepting costly interest parity deviations. Monetary policy complements FX policy by taking a disinflationary stance.

This paper examines the macroeconomic cost and implications of transitioning to net zero for a fossil-fuel-dependent, small open economy. A net zero target operates as an anticipated negative productivity shock that lowers consumption, raises the current account surplus along the transition path, and has ambiguous effects on the real exchange rate. A transition to net zero appreciates the currency by lowering the import bill for fossil fuels, but depreciates the currency by making domestic tradables more expensive. We calibrate the model to the case of Japan and find that the transition to net zero lowers consumption by 0.2-2%.

This paper proposes a novel, demand-side explanation for the Penn effect: the observation that richer countries systematically exhibit higher price levels. We develop a general equilibrium model where income-dependent preferences lead more productive countries to produce and consume higher-quality, more resource-intensive non-tradeable goods. Our key result is that this endogenous shift toward producing superior goods, which have higher unit factor requirements, outweighs the standard cost-reducing effects of productivity growth, resulting in higher prices. The model shows that quality upgrading emerges as an equilibrium response to rising incomes and leads to higher non-tradeable prices in richer economies even in the absence of Harrod-Balassa-Samuelson (HBS) effects. Using Penn World Table data, the model replicates the empirical Penn effect, explaining about 69 percent of cross-country price variation without relying on HBS effects.

Emerging economy central banks often hold large FX reserves while residents carry substantial local-currency-linked external liabilities. With financial frictions creating interest parity gaps, such opposing positions imply a carry cost. In a small open economy with intermediation frictions and inherited local-currency debt, we study optimal reserve and exchange rate policies, explaining why debtor economies may retain reserves rather than netting out costly gross positions. While policy can eliminate costly intermediation by deploying reserves and appreciating the real exchange rate, doing so creates a general equilibrium revaluation effect which raises the real burden of local-currency obligations. Optimal policy retains reserves, accepting some intermediation to avoid a larger revaluation loss. This policy is time-inconsistent: a discretionary central bank prefers stronger ex-post appreciation; a time-consistent equilibrium features more reserve retention and larger interest parity gaps. Revaluation costs restrain reserve deployment; when large, optimal policy retains more reserves during disruptions than in normal times.

This study explores the long-run equilibrium relationship between India's real exchange rate and sectoral productivity trends using internationally comparable KLEMS productivity databases for India, China, the euro area, the USA, the UK, and Japan. This study uses pooled mean group estimations for panel data, as suggested by Pesaran et al. (1999). The results support an "extended" Balassa-Samuelson (BS) hypothesis, which allows for labour market frictions that prevent wage equalisation between traded and non-traded sectors within a country. This mechanism continues to find support when we separate out the distribution sector, which comprises wholesale and retail trade in the domestic services sector. The empirical evidence suggests that India's real exchange rate is anchored to domestic fundamentals and is closely aligned with its fair value over a medium- to long-term horizon.

The persistent variation among Indian states in per-capita value added from the manufacturing sector raises the question of whether the long-run equilibrium in the manufacturing sector differs across states. In this paper, we provide empirical evidence on whether labour disputes in the form of strikes, lockouts, temporary closures, and related disruptions have caused variation in these equilibria in the recent period. Available data suggest that in 9 out of 16 states in our sample, labour disputes generally declined between 2001 and 2017, while in others, labour disputes were mostly characterised as random shocks with little predictability. Our two-stage least squares estimates, using states' election cycles as an instrument for labour disputes, suggest that these low-persistence labour disputes did not have much influence over inter-state differences in equilibrium capital-labour ratios in "registered" manufacturing units between 2001 and 2017. However, a 1 percent increase in labour disputes might be associated with a 3.2 percent reduction in total factor productivity for the sector in states where disputes were random events. In the remaining states, where labour disputes have consistently fallen over time, this effect is significantly reduced. Our findings are robust in a different sample of firms.