Following a sudden stop, real exchange rates can realign through a nominal exchange rate depreciation, lower domestic prices, or a combination of both. This paper makes four contributions to understand how the type of adjustment shapes the response of macroeconomic variables, in particular, productivity, to such an episode. First, it documents that TFP systematically collapses after a sudden stop under a flexible exchange rate arrangement while it moderately improves if taking place within a currency union. Second, using firm-level data for two sudden stops in Spain, it highlights that the difference in the productivity response is largely driven by entry and exit firm dynamics. Third, it proposes a small open economy DSGE framework with firm selection into production and endogenous mark-ups that is consistent with the empirical findings. The model nests three mechanisms through which a shock affects productivity: a pro-competitive, a cost, and a demand channel. While only the former operates when the nominal exchange rate adjusts, all three are active under a currency union. The model delivers general conditions under which the demand channel dominates in the latter scenario. Fourth, it uses a quantitative version of the model to revisit the optimality of exchange rate policy after a sudden stop.
WORK IN PROGRESS
How Do Central Banks Control Inflation? A Guide For the Perplexed (joint with Ricardo Reis).
Paying Bankers: Rents, Risk, and Performance (joint with Sophia Chen and Deniz Igan).
Dual Mandates and Excessive Hawkishness: a Principal-Agent Approach.