Remittances, Monetary Regimes and Nontradable Inflation

Dynamics

Emmanuel K.K. Lartey∗

California State University-Fullerton.

February 22, 2013

Abstract

This paper examines the dynamic and desirable properties of monetary regimes in a remittances

recipient economy, with an emphasis on the effect on sectoral output and nontradable inflation

dynamics. The findings indicate that under a fixed exchange rate regime, an increase in remittances

creates increased demand for nontradable goods, and hence a rise in nontradable inflation as well

as expansion in output of nontradables. Under a nontradable inflation targeting regime, however,

a decrease in nontradable inflation, and an expansion in tradable goods production are observed

following an increase in remittances. A near-zero nontradable inflation rate, and a managed

variability in the nominal exchange rate typifies the optimal monetary policy, suggesting that an

inflation targeting regime is preferable to a fixed exchange regime under such a scenario. A VAR

analysis shows that the dynamics of inflation in El Salvador and the Philippines are in consonance

with those observed in the model under the fixed exchange rate and nontradable inflation targeting

regimes respectively.

JEL Classification : E52 F24 F41

Keywords : Monetary policy, Nontradable inflation, Real exchange rate, Remittances

∗Department of Economics, California State University, Fullerton, 800 N. State College Blvd, Fullerton, CA 92834.

E-mail: elartey@fullerton.edu, Tel.: 657-278-7298, Fax: 657-278-3097.

1

1 Introduction

There has been a significant increase in both the magnitude and growth rate of remittances to devel-

oping countries in recent years, to the extent that they have surpassed the inflow of official aid and

private capital. Recorded remittances to developing countries reached $338 billion in 2008, a significant

increase from previous levels of $240 billion in 2007, $221 billion in 2006 and more than double the

level in 2002. In comparison, total net private capital flows to developing countries, comprising FDI,

portfolio equity and private debt, was about $700 billion in 2008. Also, remittances were more than

twice the level of official development assistance (ODA) flows to developing countries in 2007. The

literature has documented that high levels of remittances are associated with lower poverty indicators

and high growth rates (Adams and Page, 2005; Acosta et al, 2008). It has also been argued that remit-

tances finance investment in human capital, smooth consumption and have multiplier effects through

increased household expenditures (Gupta et al., 2009). Other studies have indicated that rising levels

of remittances could be harmful to the growth prospects of recipient economies through appreciation of

the real exchange, and resource allocation from the tradable to the nontradable sector; characteristic

of the phenomenon known as the Dutch disease (Acosta et al., 2009).

The magnitude of remittances flows, therefore, has raised critical questions with respect to the

potential undesirable effects on the recipient economies, similar to those that emerged during periods

of massive capital inflows to emerging market economies in the 1990s. The massive inflow of foreign

currency could be associated with real exchange rate appreciation and loss of international competi-

tiveness, which in turn could lead to a decline in the production of tradable goods. The experiences of

some countries suggest that prices of financial assets and especially of real estate could rise following

increases in remittances, culminating in resource reallocation toward these sectors. Arguably, such out-

comes will alter the growth prospects of these countries, which provokes the question of whether policy

responses should be resorted to in an effort to address such unfavorable consequences of remittances.

I utilize a two-sector, small open economy model incorporating remittances and sticky nontradable

prices, to analyze the implications of an increase in remittances on resource reallocation and non-

tradable inflation, which has implications for real exchange rate movements. I focus primarily on the

2

role of exchange rate and monetary policies for these dynamics following an increase in remittances,

and address the desirablity of such policies. Chami et al. (2006) and Mandelman (2011) consider

the role of monetary policy in economies that receive remittances. Chami et al. (2006), using a

flexible-price model with cash-in-advance constraints, show that the introduction of remittances into

a closed-economy alters the standard optimal Friedman Rule. Mandelman (2011) examines the stabi-

lization role and welfare implications of monetary and exchange rate policies in a small open economy

that is subject to remittances fluctuations. The study shows that a fixed exchange regime provides a

better outcome for households facing rising trend in remittances, while a flexible regime does better

when unantipated shocks over the business cylce are considered. As a departure, this paper empha-

sizes the impact of monetary and exchange rate policies on resource reallocation across sectors and

their implication for nontradable inflation, and consequently the real exchange rate when there is an

increase in remittances. I also perform an analysis to ascertain what the optimal policy would be from

a welfare perspective.

Acosta et al. (2009) use a real business cycle model to show that irrespective of the motive for

sending remittances, that is whether it is altruistic or for self-interest, an increase in remittances leads

to an increase in consumption demand that is biased toward non-tradables, and hence higher non-

tradable prices. This culminates in an an expansion of the nontradable sector to the detriment of the

tradable sector. The study also finds that remittances improve welfare of households by increasing the

levels of consumption and leisure. Arguably, the dynamics generated by remittances in a non-flexible

price environment where there is a role for monetary policy would be different under different monetary

and exchange rate regimes. Moreover, there has been ongoing debate among policy makers about the

desirability of managing real exchange rate appreciation following inflow of remittances in order to

enhance the external competitiveness of recipient countries, as well as their potential for growth.

This paper, therefore, provides an essential contribution to the literature by examining the dynamic

and desirable properties of monetary policy in an economy that is a recipient of remittances, with an

emphasis on the impact on sectoral resource reallocation and nontradable inflation dynamics. A

fixed exchange rate regime which represents the policy stance in a country like El Salvador, serves

3

as the benchmark rule against which Taylor-type rules that allow for some nominal exchange rate

flexibility while trageting nontradable inflation, are compared in terms of the dynamics of the model.

Unlike a fixed exchange regime that aims at preventing appreciation of the nominal exchange rate, the

alternatives represent the scenerio where the monetary authority is also concerned with real exchange

rate appreciation by way of higher prices of nontradables. I also conduct an empirical analysis using

data for El Salvador and the Philippines, two countries that are recipients of massive amounts of

remittances but operate under different monetary regimes, and examine the dynamics of inflation and

the real exchange rate based on a vector autoregressive (VAR) model.

2 The Model

2.1 Households

There is a continuum of households of unit mass. The household has preferences over real consumption

() and labor effort () supplied in a competitive market. The consumption index is an aggregate

of nontradable good ( ) and tradable good ( ); =h1 ()

−1 + (1− )

1 ()

−1

i −1

∈ [0 1], 0 Consumption of nontradable goods is differentiated, with a sub-index, =

(R 10 ()

−1 )

−1 1 The tradable consumption good is a composite of home () and foreign

() tradable goods, =

∙()

1 ()

−1 + (1− )

1 ()

−1

¸ −1

∈ [0 1], 0

The corresponding price index is =h()

1− + (1− ) ()1−

i 11−

, where is

price of foreign tradable consumption good, is price of domestic tradable good. The consumer price

index is =£()

1− + (1− )()1−¤ 1

1− ; = (R 10 ()

1−)1

1− is the price sub-index

for the nontradable good, and is the price of the tradable consumption good. Optimal allocation

of expenditure between tradable and nontradable goods yields,

= 1−

³

´− and between

home and foreign tradables is given by

=1−

³

´−

The household’s utility function is given by

∞X=0

∙

1

1− 1− −

1+

1 +

¸ (1)

4

with 0

The budget constraint is:

+1 + ∗+1 +

2(

∗+1)

2 + + +1

= (1 + ) + (1 + ∗ )∗ + ( + ) + + + +Π (2)

The representative household enters each time period with shares of the production unit of the

tradable sector purchased from the previous period, and earns a return ( + ) on shares held from

the previous period; is the period price of a claim to the tradable sector firm’s entire future profit,

and is period dividends issued by the firm. is remittances, and ∗ are nominal interest

rates on bonds denominated in home () and foreign (∗) currencies respectively is the nominal

wage, is the nominal exchange rate, and Π represents profits of the nontradable sector.2(∗+1)

2

is cost of adjustment for foreign bond holdings relative to zero, introduced to ensure steady-state

determinacy and model stationarity in response to temporary shocks. This can be considered as

financial intermediation cost, where the financial intermediaries are local perfectly competitive firms

owned by domestic households. is the rebate of financial intermediation fees to the household.

The optimality conditions for the household’s choices are:

− =

∙−+1(1 + +1)

+1

¸ (3)

−

∙ + (

∗+1

)

¸=

∙−+1+1(1 + ∗+1)

+1

¸ (4)

− =

∙−+1(+1 + +1)

+1

¸ (5)

−

= (6)

5

2.2 Firms

Production occurs in two sectors; tradable and nontradable. The tradable sector consists of investment

and production units. Capital is used in the tradable sector only, hence the nontradable good is

produced using labor.1 Capital acquisition is subject to adjustment costs. The capital stock changes

according to +1 = +(1−) where is the depreciation rate, and the adjustment cost of capital

measured in terms of the tradable good is given by 2

³− ´2

where governs the size of the

adjustment cost. The total domestic labor supply is = + where is tradable sector labor

and is nontradable sector labor. I assume a unit of tradable good can be costlessly transformed

into a unit of home investment.

2.2.1 Tradable Sector

Investment Unit The investment unit combines home investment () and foreign investment

( ) to produce investment () to maintain and accumulate capital, using the technology, =h1 ()

−1 + (1− )

1 ()

−1

i −1

where 0 and 0 ≤ 1 The unit cost of investment

is, =£()

1− + (1− )()

1−¤ 11− ; is the price of domestic tradable good and

is the price of foreign investment in domestic currency, where =

∗ and ∗

is the foreign

currency price.

The unit’s minimization problem is,

min{ }

+

h1 ()

−1 + (1− )

1 ()

−1

i −1

=

and the optimal choices are

= (1− )

Ã

!− (7)

=

µ

¶− (8)

1This follows the modeling strategy used by Acosta et al. (2009).

6

Production Unit The production unit produces a tradable good using technology, = exp {}

1−;

0 1 where is a productivity shock. The unit maximizes the present discounted value of div-

idends,

P∞= Λ

h −

³ +

2( − )2

´−

i subject to +1 = + (1 −

)2 The optimal choices for +1 and respectively are

Λ+1

µ+1

+1

+1

− +1

∙

2(+1

+1

− )2 − (+1

+1

− )+1

+1

¸++1(1− )

¶= (9)

µ1 + (

− )

¶= (10)

(1− )

=

(11)

Equation (9) is an investment Euler equation which describes the evolution of and equation

(10) determines the investment rate as a function of Tobin’s , which in this case is

i.e. the ratio

of the shadow price of capital to the price of investment. Equation (11) describes demand for labor.

2.2.2 Nontradable Sector

I assume the nontradable sector consists of is a continuum of monopolistically competitive firms of

measure unity, each producing output with the production function

() = exp {}() (12)

where is a stochastic productivity parameter for the nontradable sector following the (1) process

+1 = + +1 0 1; ∼ (0 )

Firms demand labor in a perfectly competitive fashion, taking the wage and level of output as

2−

= Λ for = + 1 + 2 is the stochastic discount factor.

7

given. The static efficiency condition for labor demand is:

()

()=

(13)

where =

is the real marginal cost, the inverse of which is the markup, which is common across

firms.

Price Setting Firms in the nontradable sector set prices á la Calvo (1983), and (1 − ) is the

probability of changing the optimal price (). The optimal pricing condition is

() =

1−

P∞=0

Λ+++()

P∞=0

Λ++() (14)

where () represents the newly set price for a firm that adjusts its price in period Equation (14)

is a dynamic markup equation by which nontradable good firms forecast future demand and marginal

costs in setting the price. Standard aggregation results imply that the price of the nontradable good

evolves according to the rule

=h 1−−1 + (1− ) 1−

i 11−

(15)

A combination of the log-linearized versions of (14) and (15) produces the forward-looking Philips

curve,

= +1 +(1− )(1− )

c (16)

where c represents the log deviation of real marginal cost from its steady-state level.3

3The modeling strategy to feature sticky prices in the nontradable sector yields a nontradable sector-specific Philips

curve, consistent with the objective to allow the monetary authority to operate a nontradable inflation targeting regime.

8

2.3 Resource Constraints

The following equations characterize the resource constraints of the economy:

= + + (17)

= (18)

= + (19)

where is the component of tradable sector output that is exported and is aggregate output.

2.4 Remittances

I follow Acosta et al. (2009), and assume that home-born foreign residents with close family ties in the

domestic economy regularly send funds to domestic households, the remittances being independent of

domestic economic conditions.4 Fluctuations in remittances can be attributed to several causes. For

example a change in productivity improvements in a sector of the foreign economy where a migrant

is employed or changes in the costs of transferring funds. Still and all, given that this is a small open

economy model, economic variables that are determined abroad are taken as given, as they may not

be affected by domestic events. I therefore specify remittances as following an exogenous stochastic

process given by,

+1 = () exp(+1); 0 1; ∼ (0 ) (20)

2.5 Open economy expressions

The small open economy can neither affect foreign prices nor foreign output, and thus takes these

variables as given. Since I are conducting the analysis in terms of real variables only, I normalize the

4Acosta et al. (2009) show that the motivation for sending remittances has no bearing on the dynamics in their model

in terms of Dutch disease effects. In effect, the dynamics associated with this specification describing the behavior of

remittances can be generalized to apply to other cases.

9

nominal exchange rate to a value of unity. The real exchange rate is defined as the ratio of the

price of foreign consumption basket to the domestic one:

=∗

(21)

where ∗ is the foreign consumer price index in units of foreign currency, and is the nominal

exchange rate. Equation (21) shows that a rise in the price of domestic nontradables leads to an

appreciation of the real exchange rate. I follow Gertler et al. (2007) and postulate an empirically

reasonable reduced form export demand curve: =

; 0 where

is aggregate output in

the foreign economy.

2.6 Monetary policy

I examine the dynamics of the model under alternative monetary policy regimes. The monetary

authority uses the nominal interest rate as the policy instrument and follows a set of policy rules derived

from a generalized Taylor rule, such that deviations of nontradables inflation, gross domestic product

(GDP), nominal exchange rate depreciation and real exchange rate depreciation from their respective

steady state levels feed back on the interest rate.5 The general form of the equation describing the

policy rules is,

(1 + +1) = (1 + ) (1 + )

µ

¶ ³

´ µ

−1

¶ (22)

where , , , ≥ 0 are the reaction coefficients on nontradable price inflation, GDP (Y),nominal exchange rate depreciation, and real exchange rate depreciation respectively, and and

are the steady-state real interest rate and GDP respectively. The baseline rule is a fixed exchange

rate regime under which the coefficient is assigned an arbitrarily high value, such that = for

any , where is a target level for the nominal exchange rate. The other rules comprise a standard

Taylor rule given by equation (22) with = = 0 , and an open-economy version of the Taylor

5Aggregate output (GDP) in the model is defined as the value of output of all sectors.

10

rule characterized by the case with = 0.

3 Monetary regimes and model dynamics

I analyze the dynamics of the model economy under alternative monetary regimes following the inflow

of remittances. In particular, I focus on sectoral output and nontradable inflation dynamics under a

fixed exchange regime in comparison to an inflation targeting regime.

3.1 Calibration

The parameter values are set in line with the literature. I choose the following based on estimates

and calibrations in Acosta et al. (2009); household discount factor = 099which implies that the

annual real interest rate is 4%, inverse of the intertemporal elasticity of substitution in consumption,

= 2, share of capital in tradable good production, = 033 elasticity of substitution between home

and foreign tradable consumption goods, = 055, share of home goods in composite tradable good,

= 04 the degree of persistence for remittances shock, = 095, the share of home investment,

= 05 and the share of tradables in the consumption basket, = 045 The depreciation rate = 005

and the inverse of elasticity of labor supply, = 083 are chosen following Kose and Riezman (1999).

I set the rate at which the marginal adjustment cost of bond holdings changes, = 001 as in Lartey

(2008), so to ensure stationarity. The elasticity of substitution between tradable and nontradable

goods in the consumption basket, = 14 is based on an estimate for developing countries in Ostry

and Reinhart (1992). The parameter associated with the disutility of labor supply = 1 and the

share of tradable good in the consumption basket, = 045 are set following Devereux et al. (2006).

I follow the standard in the literature on Calvo-style pricing behavior, and set the probability of price

non-adjustment = 075 For the benchmark Taylor rule reaction coefficients, = 15, = 05,

= 02

11

3.2 Fixed exchange rate regime

The impulse responses under a fixed exchange regime are presented in Figures 1. An unanticipated

one percentage point transitory increase in the amount of remittances households receive leads to an

increase total consumption as both demand for both tradables and nontradables go up. The increase

in nontradables consumption drives up demand for nontradable sector labor as well as output in

that sector. This draws labor away from the tradable sector. In addition, the household’s increased

consumption of tradables comes at the expense of investment, leading to no change in the capital

stock. The combination of these effects causes a contraction of the tradable sector. The increased

demand for nontradable goods triggers a rise in nontradable prices, and hence nontradable inflation,

which indicates an appreciation of the real exchange rate.6

3.3 Inflation targeting regime

Figure 2 shows the dynamics under two inflation targeting regimes; the standard Taylor rule and the

open-economy Taylor rule, in comparison to the fixed exchange rate regime dynamics. Under both

inflation targeting regimes, an exogenous increase in remittances on impact, leads to a decrease in

consumption of both tradables and nontradables. The decrease in tradable consumption is due to

channeling of the windfall income (remittances) towards capital accumulation (increased investment)

as households purchase shares. The decrease in consumption of nontradables, on the other hand, is

driven by the policy rule.7

The household knows that the policy maker will increase the interest rate if nontradable inflation

goes up, and therefore reduces demand for nontradables, which in turn decreases nontradable inflation.

The increase in capital accumulation generates an expansion in tradable output, and consequently an

increase in tradable labor. Nontradable output, in comparison, declines due to the decrease in demand.

In essence, the inflation targeting policy induces an expansion of the tradable sector, a decline in the

6The decline in tradable output and the increase in demand for nontradables that generates an expansion in non-

tradable output, summarize the resource movement effect and the spending effect respectively, usually mentioned in the

literature on capital inflows and the Dutch disease.7The differences between the dynamics of the two Taylor rules lies only in the magnitude of the impulse responses.

The qualitative implications are identical.

12

nontradable sector, and a decrease in nontradable inflation, which represents a depreciation of the real

exchange rate.8

Thus, a fixed exchange rate regime generates dynamics indicative of Dutch disease effects, following

inflow of remittances, whereas a monetary regime characterized by a Taylor-type rule averts such

dynamics, allowing for an increase in capital accumulation instead of consumption, and expansion of

the tradable sector coupled with a decline in nontradable inflation. The question then is this: which of

these policy regimes enhances welfare of the household in the event of an increase in remittances. In

other words, would the optimal monetary policy under these circumstances be one that approximates

a nominal exchange rate peg, or one that falls within the family of Taylor-type rules? This question

is addressed next.

3.4 Optimal monetary policy

I conduct a welfare analysis to determine the policy rule that is optimal from the perspective of the

household following a positive shock to remittances. The welfare criterion used is the expectation of

the second-order Taylor expansion of the household’s utility function around the steady state given by

=1−

1− −

1+

1 + +

1−()−

1+()−

21−

(2 )−

21+

(2 ) (23)

where and are steady state values of consumption and labor respectively, and variables with a

hat notation denote percentage deviations from the steady state. I assume the monetary authority

chooses the reaction coefficients to maximize the welfare function, and that it can commit to such

rules. I specify a general interest rate rule given by

(1 + +1) = (1 + )

µ

¶ µ

−1

¶ µ

−1

¶ (24)

8 It should be noted that the dynamics here are due, not to the assumption that capital is used only in the tradable

sector, but rather to the role of monetary policy in targeting nontradable inflation. In effect, even in the case where

capital is also utilized in the nontradable sector, nontradable output will still decline in response to the decrease in

demand for such goods due to the policy rule.

13

The estimates of the optimal values for the parameters of the policy rule are: = 49 = 05

= 02 = 0005 The optimal monetary policy, therefore, is characterized by a very aggresive

stance against nontradable inflation, a standard response to the output gap, and some managed

variabililty in the nominal exchange rate.9 This represents a Taylor-type rule. The dynamics of

the model under the optimal policy parameter values are shown in Figure 3, in comparison to the

dynamics under the fixed exchange rate regime. The dynamics under the optimal rule are, for the

most part, qualitatively identical to those under the benchmark Taylor rule; the impulse responses,

however, differ in amplitude. The consumption of both tradables and nontradables decrease following

an increase in remittances, but only consumption of tradables rises above the steady-state level in

the short-run. The aggressive response to nontradable inflation keeps nontradable consumption below

the steady-state until it returns there eventually. The labor supply, a key variable in the welfare

function, increases initially as the tradable sector expands, but drops below the steady-state in the

short-run. The other significant observations here are the stability in nontradable inflation and the

limited variation in total consumption under the optimal rule.

Under the optimal policy, therefore, nontradable inflation is close to zero. This is consistent with

the goal of optimal monetary policy in a sticky-price environment, which is to eliminate the distortions

associated with sticky-prices in order to deliver the flexible price allocation. Moreover, it turns out

that the stability of nontradable prices achieved under the policy averts the appreciation of the real

exchange rate that would otherwise have occured through higher nontradable prices, as observed under

the fixed exchange rate regime.10

4 VAR analysis

I perform an empirical analysis using data for El Salvador and the Philippines, two countries that

are recipients of massive amounts of remittances but operate under different monetary policy regimes.

9The reaction coefficient on nontradable inflation, is higher in simulations where the upper threshold of the

constraint is greater than the one used for the reported estimates, the highest possible estimate being 532. The other

parameter estimates are robust to a variety of constraints. This suggests that the optimal policy is typified by stability

in nontradable prices.10This also provides some explaination to the relatively low value of the reaction coefficient on the real exchange rate.

14

El Salvador is representative of an economy operating a fixed exchange rate regime, whereas the

Philippines exemplifies an economy under an inflation targeting regime. I compare the dynamics

indicated by the impulse response functions for two main variables of interest; inflation and the real

exchange rate following an exogenous increase in remittances.11 I utilize a VAR model, applying the

Cholesky decomposition with the following ordering of the variables; remittances, CPI and the real

exchange rate.12 The data on all the variables are expressed in logs. Figures 4 and 5 present the

impulse reponses with 95% confidence interval for El Salvador and the Philippines respectively.

A shock to remittances causes an increase in the CPI and appreciation of the real exchange in

El Salvador on impact, whereas in the Philippines, it barely generates any movement in the CPI but

causes a depreciation of the real exchange rate. These are in consonance with the dynamics of the

theoretical model, such that under a fixed exchange regime, an increase in remittances will likely

culminate in an appreciation of the real exchange rate through higher nontradable prices, whereas

little to no variation in nontradable inflation will be observed under an inflation targeting regime.

5 Conclusion

I examine the dynamic and desirable properties of exchange rate and monetary policies in an economy

that is a recipient of remittances, using a dynamic stochastic general equilibrium model. I lay particular

emphasis on the implication of such policies for the dynamics of sectoral output and for nontradable

inflation, which has consequencies for real exchange rate movements. The main results are as follows.

Under a fixed exchange rate regime, an increase in remittances leads to an increase in consumption of

nontradable goods, resulting in a rise in nontradable inflation which implies an appreciation of the real

exchange rate. For an inflation targeting regime, however, an increase in remittances drives up capital

accumulation, generating an expansion of the tradable sector. The policy rule operates to decrease

nontradable output as consumption of nontradables declines, thereby reducing nontradable inflation.

11The data for El Salvador is the same as in Acosta et al. (2009), covering the period 1991:Q1-2006:Q4; and the data

for the Philippines is the same as in Mandelman (2012), covering the period 1995:Q1-2009:Q4. See the two references

for details on the data.12The CPI is a good proxy for nontradable prices, given that prices of tradables are exogenously determined for small

open economies.

15

A VAR analysis also indicates that these observations are generally consistent with the dynamics of

inflation induced by a shock to remittances in El Salvador, which is representative of an economy that

operates a fixed exchange regime, and the Philippines, which typifies an economy with an inflation

targeting monetary regime.

Furthermore, I analyze the desirable properties of exchange rate and monetary policies under such

a scenario. The optimal policy is characterized by a managed variability in the nominal exchange rate,

and a very aggressive reaction to nontradable inflation which ensures that nontradable inflation is

close to zero. The optimal policy, therefore, averts a real exchange appreciation that would otherwise

occur through higher nontradable prices, while encouraging an expansion of the tradable sector. This

provides a key contribution to the literature and the growing debate among policy makers on the

desirability of managing real exchange rate appreciation following inflow of remittances in order to

enhance the external competitiveness of recipient countries, as well as their potential for growth; the

results suggesting that, from a policy perspective, a nontradable inflation targeting regime and more

generally, an inflation targeting regime should be preferable to a fixed exchange rate regime.

16

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[2] Acosta, Pablo .A., Mandelman, Federico S., and Lartey, Emmanuel K.K. (2009), “Remittances

and the Dutch Disease.” Journal of International Economics 79:102—116

[3] Adams, Richard and John Page. (2005), “Do International Migration and Remittances Reduce

Poverty in Developing Countries?” World Development 33:1645—69

[4] Calvo, G. (1983), ‘Staggered prices in a utility-maximizing framework,’ Journal of Monetary

Economics 12:383-398.

[5] Chami, R., Cosimano, T., Gapen, M., (2006). Beware of emigrants bearing gifts: optimal fiscal

and monetary policy in the presence of remittances. IMF Working Papers 06/61.

[6] Devereux, Michael B., Philip R. Lane and Juanyi Xu, "Exchange Rates and Monetary Policy in

Emerging Market Economies," Economic Journal 116 (2006):478-506.

[7] Gertler, M., Gilchrist, S., Natalucci, F., (2007). External constraints on monetary policy and the

financial accelerator. Journal of Money, Credit and Banking 39, 295—330.

[8] Gupta, Sanjeev, Catherine A. Pattillo, and Smita Wagh. (2009), “Effect of remittances on poverty

and financial development in sub-Saharan Africa.” World Development 37:104—15

[9] Kose, M. Ayhan and Raymond Riezman, "Trade Shocks and Macroeconomic Fluctuations in

Africa," CSGR Working Paper No.43/99, University of Warwick, 1999.

[10] Lartey, Emmanuel K.K., "Capital Inflows, Dutch Disease Effects and Monetary Policy in a Small

Open Economy," (2008) Review of International Economics 16:5, 971-989

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ations.” Journal of Development Economics. Forthcoming

17

0 10 20 300

0.5

1

quarters

remittances

0 10 20 300

0.05

0.1

0.15

0.2

quarters

nontradable inflation

0 10 20 30-0.1

0

0.1

0.2

0.3

quarters

labor supply

0 10 20 300

0.1

0.2

0.3

0.4

quarters

total consumption

0 10 20 30-0.5

0

0.5

1nontradable consumption

0 10 20 300

0.01

0.02

0.03

0.04tradable consumption

0 10 20 30-0.2

-0.15

-0.1

-0.05

0tradable labor

0 10 20 30-0.5

0

0.5

1nontradable labor

0 10 20 30-0.05

0

0.05

0.1

0.15share price

0 10 20 300

0.05

0.1capital

0 10 20 30-0.1

-0.05

0tradable output

0 10 20 30-0.5

0

0.5

1nontradable output

Figure 1. Impulse responses under fixed exchange rate regime

18

0 10 20 300

0.5

1

quarters

remittances

0 10 20 30

-0.6

-0.4

-0.2

0

quarters

nontradable inflation

0 10 20 30-1.5

-1

-0.5

0

0.5

quarters

labor supply

0 10 20 30

-0.6

-0.4

-0.2

0

0.2

quarters

total consumption

0 10 20 30

-0.5

0

0.5

tradable consumption

0 10 20 30

-1.5

-1

-0.5

0

0.5

nontradable consumption

0 10 20 30

-1

0

1

2

tradable labor

0 10 20 30

-1.5

-1

-0.5

0

0.5

nontradable labor

0 10 20 300

0.5

1

1.5

2

capital

0 10 20 300

5

10

share price

0 10 20 30

0

0.5

1

1.5

tradable output

0 10 20 30

-1.5

-1

-0.5

0

0.5

nontradable output

Figure 2. Impulse responses under fixed exchange rate regime (triangles), open-economy Taylor rule

(circles) and Taylor rule (squares)

19

0 10 20 300

0.5

1

quarters

remittances

0 10 20 300

0.05

0.1

0.15

quarters

nontradable inflation

0 10 20 30

-0.1

0

0.1

0.2

quarters

labor supply

0 10 20 30

0

0.1

0.2

0.3

quarters

total consumption

0 10 20 30

-0.05

0

0.05

0.1

tradable consumption

0 10 20 30

0

0.2

0.4

0.6nontradable consumption

0 10 20 30-0.2

0

0.2

tradable labor

0 10 20 30

0

0.2

0.4

0.6nontradable labor

0 10 20 300

0.1

0.2

0.3

capital

0 10 20 300

0.5

1

share price

0 10 20 30

0

0.1

0.2tradable output

0 10 20 30

0

0.2

0.4

0.6nontradable output

Figure 3. Impulse responses under optimal monetary policy (squares) and fixed exchange rate regime

(triangles)

20

Figure 4 Impulse responses to remittances shock - El Salvador

consumer price index

real exchange rate

21

Figure 5 Impulse responses to remittances shock - Philippines

consumer price index

real exchange rate

22