The Distributional Effects of Nominal Exchange Rate Depreciations: Theory and Evidence
Mario Giarda (Banco Central de Chile)
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Abstract:
A common policy prescription is that, during foreign-shock–induced recessions, small open economies should depreciate the nominal exchange rate (ner) to lower real wagesand limit unemployment spikes. This paper qualifies that prescription by incorporating the distributional consequences of a ner depreciation. Using administrative employer-employee data from Chile, we estimate heterogeneous labor-market responses to twocentral foreign shocks: a commodity-price shock and a global financial shock. When foreign shocks are followed by a ner depreciation, real wages fall more and unemployment rises less; when the ner is stable, unemployment spikes especially for low-incomeworkers. We argue that wage rigidity and the monetary-policy response explain these patterns. We build a quantitative small-open-economy theory with heterogeneous workers, incomplete markets, wage rigidities, and search frictions that matches the empiricalfindings. Stabilizing the ner can raise welfare relative to depreciation-based adjustment by avoiding an economy-wide erosion of real wages, even at the cost of higher unemployment.
