Emerging economic talent illuminates the significance of exchange rates

In the United States, exchange rates aren’t a prominent discussion point, largely because the dollar prevails in international commerce and serves as the standard for other currency valuations.

“However, in numerous nations across the globe, exchange rates play a significant role,” remarked Professor of Economics Oleg Itskhoki, Ph.D. ’09. “In smaller, open economies such as Canada, Australia, Switzerland, or even the United Kingdom and Japan, the exchange rate holds substantial importance. If you converse with central bankers in these regions, they often prioritize the exchange rate over inflation.”

Itskhoki, an up-and-coming figure in global economics, became a part of the Harvard faculty last summer. The Russian-born macroeconomist is primarily recognized for collaborating with Dmitry Mukhin on various papers that explore the reasons why exchange rates against the U.S. dollar do not always align with macroeconomic fundamentals such as consumption, productivity, and monetary policy. Instead, elements within a nation’s financial markets tend to be the primary influence.

At the core of this analysis is a more precise framework for comprehending exchange rates between currencies around the world. Itskhoki’s contributions earned him the American Economic Association’s 2022 John Bates Clark Medal, a prestigious honor acknowledging significant advancements made by economists under 40.

“Even if Oleg hadn’t received the Clark Medal, he would still be a valuable addition to our department,” commented Kenneth Rogoff, a professor of economics and Maurits C. Boas Chair of International Economics. “There are essentially two divisions of international economics: international trade and international macroeconomics. It’s quite rare, yet Oleg has positioned himself as a leader in both. He’s an extraordinary intellectual force.”

Itskhoki, whose background includes faculty roles at UCLA and Princeton, initially arrived at Harvard as a Ph.D. candidate in the mid-2000s. His mentors included Elhanan Helpman, Ph.D. ’74; Pol Antràs; and Gita Gopinath (currently on leave since 2019 for leadership roles at the International Monetary Fund).

All three experienced faculty collaborated with Itskhoki on research regarding trade, globalization, and inequality. A collection of papers with Gopinath and the late economics professor Emmanuel Farhi examined the macroeconomic influence of border tariffs.

“When you impose an import tariff, your exchange rate appreciates instantly, which adversely affects your exporters even before the tariff takes effect,” Itskhoki clarified. “Few individuals outside the field of economics grasp that an import tariff is actually equivalent to an export tax — a significant and rather universal insight from a 1936 paper by Abba Lerner that has been essential to much of my research.”

However, Itskhoki firmly situates his work within the lineage of Rogoff, an eminent authority on international finance who functioned as the IMF’s chief economist from 2001 to 2003.

“A significant portion of my work continues the efforts Ken initiated 20 to 30 years ago,” noted Itskhoki, who has an aged copy of “Foundations of International Macroeconomics” (1996), co-authored by Rogoff, in his new office at the Littauer Center.

In 2001, Rogoff co-wrote an impactful paper proposing a unified theory to address many critical enigmas in international macroeconomics. The purchasing-power-parity puzzle, for instance, pertains to the inconsistency in product pricing across nations, even after adjustments for exchange rates.

Beginning in 2016, Itskhoki collaborated with Mukhin, who is now with the London School of Economics, to re-examine many of the enigmas related to exchange rates addressed in Rogoff’s work. Their initial paper, published in 2021, introduced a straightforward model that resolved these issues while providing more accurate predictions of exchange rates among global currencies.

Regarding the purchasing-power-parity puzzle, Rogoff attributed it to individuals’ preference for domestically produced items. Itskhoki’s research offered further understanding.

This puzzle-solving research initiative is far from finished. Itskhoki and Mukhin recently released their second substantial paper in their series, enhancing their framework to challenge preceding exchange-rate models that rely on factors like inflation, productivity, or consumer demand.

“We demonstrate that elements like the demand for a nation’s assets must be more influential in determining the exchange rate than those related to the supply of goods and monetary policy,” stated Itskhoki.

Two additional publications are currently in preparation, both available as working documents. The first outlines how economic sanctions affect exchange rates, using the valuation of the ruble following Russia’s full-scale invasion of Ukraine in 2022 as a test case. The latter utilizes the entire series to present recommendations for policymakers globally.

“Should nations form a currency union like the Eurozone?” Itskhoki posited. “What are the advantages and disadvantages of discarding independent currencies — of embracing a unified monetary policy — while sacrificing exchange rate flexibility? Is it beneficial for the central bank to establish a floating exchange rate? Should they fix it partially? Fully? It seems peculiar to consider these inquiries without a dependable framework that can replicate the actual characteristics of exchange rates.”