Description

The exchange rate is a crucial variable in all open economies. It plays a key role in the transmission of external shocks to the domestic economy and in the transmission of monetary policy actions. Prolonged exchange rate misalignments have been associated with many crises that have struck emerging economies. Flexible exchange rates and credible monetary policies have reduced the impact of exchange rate fluctuations on inflation. However, as this paper argues, this has not reduced the expenditure-switching effect by which exchange rate fluctuations affect resource allocation and external adjustment. The discussion is illustrated with evidence for the Chilean economy.