Why devaluation isn’t a viable option for Greece: Insights from a small open economy | vox – Research-based policy analysis and commentary from leading economists

The essential point missing from the recent debate, is that small open economies are different: international economic shocks hit them especially deep and hard, and in the short term they have little choice but to absorb the blows and try to remain on their feet. Above everything, they should protect the value of the currency, by allowing the shock to feed through to a fall in real income. If there is to be active fiscal management, it should be in the service of maintaining the exchange rate anchor by matching import spending to foreign exchange inflows. Targeting the money supply or inflation, with a flexible exchange rate – the conventional policy prescription – produces a worse result. There is no additional foreign exchange earned or saved, real income falls by as much as is necessary to balance the external accounts in any event, and exchange rate depreciation imposes an avoidable inflation penalty that becomes entrenched in expectations.

via Why devaluation isn’t a viable option for Greece: Insights from a small open economy | vox – Research-based policy analysis and commentary from leading economists.

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