Edouard Challe, European University Institute, Florence
"Inequality and optimal exchange-rate stabilization"
We study optimal exchange rate stabilization in a tractable Small Open HANK Economy with endogenous consumption risk and rich cross-sectional inequalities. Besides the closed-economy channels, aggregate demand management operates through the real exchange rate, which affects both GDP (through expenditure switching) and national income (through the relative price of foreign goods) and ultimately feeds back to domestic cross-sectional heterogeneity. We show that this channel requires stabilizing the exchange rate more in HANK than in RANK after a domestic productivity shock; this is because stabilizing the exchange rate mitigates expenditure switching and the implied fluctuations in consumption risk and inequalities. In contrast, the optimal response to capital-flow shocks in HANK resembles that in RANK.
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Contact person: Emiliano Santoro