Research Insights: Can Exchange Rate Management Improve Welfare in Small Open Economies?

By reducing macroeconomic volatility, exchange rate management can generate significant welfare gains in economies with a high degree of trade openness. A country like Singapore, with trade openness (exports imports) at 280% of GDP, has benefited significantly from managing the exchange rate, showing 1.5% welfare gains in permanent consumption, when compared to the mainstream interest rate rule in which the exchange rate floats freely. In the case of an emerging free-floater economy like Chile, any degree of trade openness above 100% (currently at 70%) would also justify using a managed exchange rate policy that avoids excessive exchange rate volatility.