Rising econ star sheds light on power of exchange rates

Exchange rates aren’t a hot topic in the U.S., due to the dollar dominating global trade and acting as the benchmark for all other currency valuations.

“But in most countries of the world, the exchange rate looms very large,” said Professor of Economics Oleg Itskhoki, Ph.D. ’09. “In smaller open economies like Canada, Australia, Switzerland, or even Great Britain and Japan, the exchange rate matters quite a lot. Talk with central bankers in these countries, and they’re often more interested in the exchange rate than in inflation.”

Itskhoki, a rising star in international economics, joined the Harvard faculty last summer. The Russian-born macroeconomist is best known for partnering with Dmitry Mukhin on a series of papers showing why exchange rates against the U.S. dollar don’t always move with macroeconomic fundamentals like consumption, productivity, and monetary policy. Instead, factors in a country’s financial markets are the dominant driver.

At the center of the analysis is a more accurate framework for understanding exchange rates between currencies worldwide. Itskhoki was recognized for his work with the American Economic Association’s 2022 John Bates Clark Medal, a prestigious award recognizing significant contributions by economists younger than 40.

“But even if Oleg hadn’t won the Clark Medal, he would be someone we want in this department,” said Kenneth Rogoff, a professor of economics and Maurits C. Boas Chair of International Economics. “There are really two branches of international economics: international trade and international macroeconomics. It’s very unusual but Oleg has established himself as a leader in both. He’s just a tremendous intellectual force.”

Itskhoki, whose resume includes professorships at UCLA and Princeton, initially landed at Harvard as a Ph.D. student in the mid-’00s. His advisers included Elhanan Helpman, Ph.D. ’74; Pol Antràs; and Gita Gopinath (on leave since 2019 for leadership roles at the International Monetary Fund).

All three faculty veterans partnered with Itskhoki on research related to trade, globalization, and inequality. A series of papers with Gopinath and the late economics professor Emmanuel Farhi turned a macroeconomic lens on the real-world impacts of border taxes.

“When you announce an import tariff, your exchange rate appreciates immediately and this actually hurts your exporters even before the tariff is in place,” Itskhoki explained. “Few people outside the economics profession appreciate the fact that an import tariff is, in fact, equivalent to an export tax — a very import and rather general insight from a 1936 paper by Abba Lerner that has been quite central for a lot of my research.”

But Itskhoki situates his work squarely in the tradition of Rogoff, a leading expert on international finance who served as the IMF’s chief economist from 2001 to 2003.

“A lot of my work is a continuation of what Ken started 20, 30 years ago,” said Itskhoki, who keeps a weathered edition of “Foundations of International Macroeconomics” (1996), which Rogoff co-authored, in his new office at Littauer Center.

In 2001, Rogoff co-authored an influential paper advancing a unified theory to explain many of the big puzzles in international macroeconomics. The purchasing-power-parity puzzle, for example, concerns how prices for the same product can vary from one country to the next even when adjusted for exchange rates.

Starting in 2016, Itskhoki partnered with Mukhin, now with the London School of Economics, to rethink many of the puzzles related to exchange rates in Rogoff’s analysis. Itskhoki and Mukhin’s first paper, published in 2021, introduced a simple model that solved these puzzles while more accurately predicting exchange rates between currencies worldwide.

As for the purchasing-power-parity puzzle, Rogoff chalked it up to  citizens’ preference for domestically produced goods. Itskhoki’s work offered additional insights.

“He fleshes out the role of financial markets as well as the importance of monopoly in modern economies,” Rogoff explained.

This puzzle-solving research agenda is far from concluded. Itskhoki and Mukhin just published the second major paper in their series, expanding their framework to challenge previous exchange-rate modeling that hinges on factors such as inflation, productivity, or consumer demand.

“We show that forces like demand for a country’s assets must be more important in shaping the exchange rate than forces related to supply of goods and monetary policy,” Itskhoki said.

Two more publications are also in the works, both available now as working papers. The first lays out how economic sanctions impact exchange rates, with the test case being valuations of the ruble following Russia’s full-scale invasion of Ukraine in 2022. The other draws on the whole series to offer guidelines for policymakers worldwide.

“Should countries form a currency union like the Eurozone?” Itskhoki offered. “What are the costs and benefits of abandoning independent currencies — of adopting a common monetary policy — but losing the exchange rate flexibility? Is it good for the central bank to set a floating exchange rate? Should they partially fix it? Fully fix it? It was odd to discuss these questions without a reliable framework that could reproduce the actual properties of exchange rates.”