Remittances,Inflation and Exchange Rate Regimes in Small Open Economies1

Remittances are private monetary transfers across borders and thus, often, involve different currencies. Yet, the rapidly growing literature on the subject often ignores the role that exchange rate regimes play in determining the effect foreign currency remittances have on a recipient economy. This study uses a theoretical model and panel vector autoregression techniques to understand the effect of remittances on GDP, inflation, real exchange rate (RER) and money supply, depending on the exchange rate regimes. Furthermore, it allows a more detailed description of the short‐run dynamics as it considers yearly but also quarterly data for 21 emerging countries. Our theoretical model predicts that remittances should temporarily increase inflation, GDP, the domestic money supply and appreciate the RER under a fixed regime, but temporarily decrease inflation, increase GDP, appreciate the RER and generate no change in the money supply under a flexible regime. These differences are largely borne out in the data. This adds to our understanding of the true effect of remittances on economies by showing that exchange rate regimes matter for the effects of remittances, especially in the short run for monetary conditions in an economy and suggests that other results in the literature that do not control for regimes may be biased.