Abstract
Modeling the regime of long run exchange rate and capital account intervention, or dynamic currency intervention (DCI), widely adopted by emerging economies, is of great importance to international economists. This paper develops a new dynamic general equilibrium model to probe the key mechanism of a DCI regime. We show clear drawbacks of models investigating the two crucial features of DCI separately. On one side, the fast capital market adjustment assumption in existing exchange rate intervention models may not be true for a long run capital market intervention economy. On the other side, the monetary neutrality treatment in long run capital control models can be violated in a strict exchange rate intervention country. Having addressed both issues, the new model in this paper provides an important reference to study the key mechanism of a DCI economy comprehensively.
Highlights
Modeling dynamic currency intervention (DCI) regime widely adopted by emerging economies, especially China, has posed great challenge to international economists
This paper develops a new dynamic general equilibrium model to probe the key mechanism of a DCI regime
We have developed a new dynamic general equilibrium model to investigate the key mechanism of a DCI regime with two core features: long run exchange rate intervention and capital control
Summary
Modeling dynamic currency intervention (DCI) regime widely adopted by emerging economies, especially China, has posed great challenge to international economists. Few researches have scrutinized the combined effects of these two features This paper fills this gap by developing a concise dynamic general equilibrium model that incorporates both features of DCI. We postulate that capital markets may adjust slower than commodity markets in DCI countries due to fast global commodity market integration and slow domestic financial market liberalization This property is different from the short-run exchange rate intervention models, which generally adopt the fast capital market adjustment assumption of liberalized financial market models [9]. We find that international monetary neutrality can be violated if certain strict conditions are not satisfied This result imposes a limitation on long-term current market control models, which explicitly or implicitly assume “money is neutral” in the long run.
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