THE IMPACT OF EXCHANGE-RATE POLICY ON INFLATION RATE IN AN OIL-EXPORTING ECONOMY

Exchange rate policy is one of the most important economic policies to be decided by governments. In countries (like the OPEC countries) where a major part of government revenues is in the form of foreign exchange earned from exports of nationalized products and minerals, the exchange rate influences government finance and budgets directly. This paper describes the structure and behavior of a model formulated to explore fixed and floating exchange rate policies in such an economy. Model‐based policy analyses show that when the government of such an economy faces a decline in foreign exchange revenues, a fixed formal exchange rate intensifies inflationary pressures and leads to a higher market exchange rate. In addition, under a fixed exchange rate policy, a decline in foreign exchange revenues results in a drastic fall of the government budget at fixed prices, while with a floating rate policy, such an erosion of government purchasing power does not occur. Copyright © 1991 John Wiley & Sons, Ltd.