Fundamental Equilibrium Exchange Rates under Contractionary Devaluation: A Peruvian Model

Some structuralists argue that devaluations are contractionary, and that exports and imports are inelastic to exchange rate movements. A simultaneous model of exports, imports, capital flows and output is used to show that in Peru only the first proposition is correct. Consequently, external equilibrium and fast growth are incompatible. Introducing Williamson′s FEER suggests that there are wild fluctuations of actual rates around FEER, and a long‐term tendency of the latter to increase. Prudent policies should seek short‐run stability and a lower FEER in the long term; it is not devaluations but their contractionary effect which should be avoided.