Response of Output Fluctuations in Costa Rica to Exchange Rate Movements and Global Economic Conditions and Policy Implications

Abstract

Applying a three-equation model incorporating the monetary policy reaction function, this study finds that the real exchange rate and real GDP exhibit a bell-shaped relationship, suggesting that real depreciation raises real output during 2000.Q1-2005.Q2 whereas real appreciation increases real output during 2005.Q3-2008.Q4 or after real GDP has reached approximately 440,000 billion colones. Other findings are that a lower ratio of government consumption spending to GDP, a lower real federal funds rate, a higher world real income, and a lower expected inflation rate would increase real output. Major policy implications are that real appreciation instead of real depreciation would raise real output after 2005.Q2, that fiscal prudence needs to be followed, and that global economic conditions including world real income and the world real interest rate are important in affecting real output for Costa Rica.