TARGETING THE REAL EXCHANGE-RATE - THEORY AND EVIDENCE

This paper presents a theoretical and empirical analysis of policies a imed at setting a more depreciated level of the real exchange rate. An intertemporal optimizing model suggests that, in the absence of chang es in fiscal policy, a more depreciated level of the real exchange rat e can only be attained temporarily. This can be achieved by means of h igher inflation and/or higher real interest rates, depending on the de gree of capital mobility. Evidence for Brazil, Chile, and Colombia sup ports the model's prediction that undervalued real exchange rates are associated with higher inflation.