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Monetary Policy Choices in Emerging Market Economies: The Case of High Productivity Growth


  • We would like to thank Shaghil Ahmed, Joshua Aizenman, Michael Dooley, Luca Guerrieri, Michael Hutchison, Dale Henderson, Ken Kletzer, Phillip McCalman, John Rogers, Nathan Sheets, Carl Walsh and two anonymous referees for helpful comments, and Solange Gouvea for excellent research assistance. The views expressed in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or any other person associated with the Federal Reserve System. Federico Ravenna acknowledges financial support from the UCSC Academic Senate.


We develop a general equilibrium model of an emerging market economy where productivity growth differentials between tradable and non-tradable sectors result in an equilibrium appreciation of the real exchange rate—the so-called Balassa-Samuelson effect. The paper explores the dynamic properties of this economy and the welfare implications of alternative policy rules. We show that the real exchange rate appreciation limits the range of policy rules that, with a given probability, keep inflation and exchange rate within predetermined numerical targets. We also find that the B–S effect raises by an order of magnitude the welfare loss associated with policy rules that prescribe active exchange rate management.