1. Remittances, Real Effective Exchange, and Monetary Policy Alexei Kireyev, IMF Денежные переводы, реальный эффективный валютный курс и денежно-кредитная политика

2. Roadmap 1. Macroeconomics of remittances 2. The impact on REER 3. Monetary policy response 4. International experience 5. Conclusions

3. 1. Remittances differ from other types of inflows, in particular aid Remittances Directed to the private sector Consumed or saved Spent on tradables and nontradables Relatively stable Procyclical with short lag Official aid Directed to the public sector Consumed and not saved Spent mainly on nontradables May be volatile Procyclical with a longer lag (1-2 years)

4. Remittances and the aggregate demand Y=(C+I) p +(C+I) g +(X-M+NY+NCT) Private sector balance Remittances are included in factor income (NY) and net current transfers (NCT). Call remittances R, other things being equal Current account (CAB) Trade balancePublic sector balance Income

5. Macroeconomic implications of remittances depend on Their use: consumption, saving or investment Their size relative to other balance of payment flows Degree of their volatility Their persistency: shock or a constant flow.

6. Impact of remittances on money supply and exchange rate Remittances Consumed NontradeablesTradeables ImportablesExportables Saved in banksoutside banks Invested Tradeables ExportablesImportables Nontradeables Case 1Case 2 Case 3

7. Case 1. Remittances saved Remittances saved in banks in foreign currency increase in money supply no impact on exchange rate in local currency increase in money supply upward pressure on exchange rate outside banks in foreign currency no impact on money supply no impact on exchange rate in local currency upward pressure on exchange rate no impact on money supply

8. Case 2. Remittances spent on consumption Remittances spent on imported goods and services in foreign currency no impact on money supply no impact on exchange rate local goods and services in local currency increase in money supply upward pressure on exchange rate in foreign currency upward pressure on exchange rate no impact on recorded money supply

9. Case 3. Remittances invested Remittances spent on investment abroad in foreign currency no impact on money supply no impact on exchange rate at home in local currency increase in money supply upward pressure on exchange rate in foreign currency no impact on exchange rate no impact on recorded money supply

10. The overall macro impact is mixed No impact on money supply if saved outside banks; spent on imports or invested abroad Increase in money supply if saved in banks in local or foreign currency; spent on consumption in local currency. No impact on the exchange rate if saved in banks and outside banks in foreign currency; sent on imports, invested abroad or locally in foreign currency Upward pressure on the exchange rate if saved in local currency in banks and outside banks; spent on consumption of local goods and services; and invested at home in local currency

11. 2. Real effective exchange rate REER Nominal exchange rate fixed No impact flexible appreciation Inflation (differential) tradable goods no impact non-tradable goods price increase

12. Channels for REER appreciation Under a fixed exchange rate regime: inflation in non-traded goods and services Under a flexible exchange rate regime: nominal exchange rate appreciation and some inflation in non-traded goods and services.

13. Volatility of remittances Remittances Shock Temporarily appreciated REER, above the equilibrium level Negative impact on competitiveness Permanent flow Permanently higher equilibrium REER No impact on the long-run competitiveness

14. Capital controls Capital mobility Ineffective monetary policy Effective monetary policy Flexible exchange rate Fixed exchange rate Trilemma 3. Monetary policy response

15. Constraints for monetary policy response to remittances Exchange rate regime Fixed Capital controls Short-term monetary policy response possible No capital controls Monetary policy response is not possible Flexible Capital controls Monetary policy response is possible and highly efficient No capital controls Monetary policy response is possible but less efficient

16. Options for monetary policy in case of REER appreciation In case of a shock from remittances and a disruptive REER appreciation resist nominal appreciation: intervene by purchasing foreign exchange to reserves resist inflation in non-tradables: – sterilize money supply by selling securities – increase reserve requirements, part in foreign exchange – raise policy interest rates In case of a permanent flow of remittances and an orderly REER appreciation do not intervene against fundamental trends smooth extreme volatility of the nominal exchange rate by two- sided interventions allow the nominal exchange rate adjust

17. Shortcomings of an active monetary policies in response to REER appreciation Sterilization increases interest rates and therefore attacks addition foreign capital and accelerated REER appreciation High interest rates and tight liquidity deprive the economy of the benefits of remittances inflow by hampering investment and growth Sterilization can be costly to the Central Bank and discourage financial intermediation.

18. REER appreciation is unlikely and monetary policy response may not be needed at all if remittances are predominantly spent on tradables (imports or transferred in kind) inflow of remittances leads to reduced interest rate on external borrowing (if external creditors consider remittances as part of country’s wealth) remittances is and established component of the current account and allow to suitably finance part of the trade deficit.

19. 4. International experience Have remittances actually led to the REER appreciation in some country? Yes: Cape Verde(Bourdet, 2003), Pakistan (Hyder, 2005), Jordan (Petri, 2006), Dominican Rep, El Salvador, Guatemala (Izquierdo, 2006), panel of 13 LA countries (Amuedo, 2004) No: Honduras, Jamaica, Nicaragua (Izquierdo, 2006), sample of 15 Latin American countries (Rajan, 2005). Have the authorities actually undertaken active monetary policy measure in response to remittances? Yes: El Salvador with mixed results, developing countries at large (Calvo et al., 1996) No: Mexico (Riuz, 208), Tajikistan (Kireyev, 2006), seven Latin Amrican countries (Ball et al, 2009) Remittances influence the choice of the exchange rate regime (Singer, 2010)

20. 5. Conclusions Impulsive and cyclical remittances may present significant challenges for macroeconomic management by destabilizing money supply and leading to REER appreciation above the equilibrium level. Active monetary policy is appropriate with the view to resist temporary REER appreciation in this case. Orderly remittances, already included in the economic structure of receiving economy, should be treated as any other regular inflows, lead to a more appreciated level of the equilibrium REER, and generally do not pose problems for macroeconomic management. Active monetary policy is not needed in this case. International evidences on whether remittances have posed serious problems for monetary and exchange rate policies are mixed but generally point to the fact the some REER appreciation should be expected.