Remittances, Output, and Exchange Rate Regimes: Theory with an Application to Latin America

Abstract

Remittances from immigrants back to relatives and friends in their home country represent a large and important flow of funds both absolutely and relative to measures of national income. Macroeconomic aggregates are impacted as well, due to the size of these flows and the fact that a significant portion of the population receives these remittances. This study by Dennis W. Jansen and Diego E. Vacaflores explicitly incorporates remittances in a small open economy to examine its influence on output under alternative exchange rate regimes. Using a simple stochastic limited participation model that is calibrated with Bayesian techniques, the authors find that the dynamics of labor, inflation, and output are dependent on the parameters of the utility function and the monetary rule governing the evolution of the interest rate. Findings show that the initial drop of output resulting from a remittances shock is similar under alternative exchange rate regimes, but the subsequent recovery of output is faster and stronger under the more flexible exchange rate regimes.