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Federal Reserve Bank of San Francisco
Working Paper Series
Currency Manipulation
Tarek A. Hassan
Thomas M. Mertens
Tony Zhang
Abstract

We propose a novel, risk-based transmission mechanism for the effects of currency manipulation: policies that systematically induce a country’s currency to appreciate in bad times, lower its risk premium in international markets and, as a result, lower the country’s risk-free interest rate and increase domestic capital accumulation and wages. Currency manipulations by large countries also have external effects on foreign interest rates and capital accumulation. Applying this logic to policies that lower the variance of the bilateral exchange rate relative to some target country (“currency pegs”), we find that a small economy pegging its currency to a large economy increases domestic capital accumulation and wages. The size of this effect increases with the size of the target economy, offering a potential explanation why the vast majority of currency pegs in the data are to the US dollar, the currency of the largest economy in the world. A large economy (such as China) pegging to a larger economy (such as the US) diverts capital accumulation from the target country to itself, increasing domestic wages, while decreasing wages in the target country.


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Tarek A. Hassan & Thomas M. Mertens & Tony Zhang, Currency Manipulation, Federal Reserve Bank of San Francisco, Working Paper Series 2016-15, 01 Dec 2016, revised 12 Aug 2008.
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DOI: 10.24148/wp2016-15
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