On the whole, the previous discussion highlights a number of problems that policy makers may have to face in the context of a surge in remittances. True, to the extent that these Dutch Disease phenomena are part of the natural adjustment process towards a new equilibrium, they should not be a matter of particular concern for policy makers. Indeed, if we view remittances as a positive shock to the economy, then the real appreciation and related effects experimented by the receiving country would simply be part of the inevitable relative price adjustment process that goes with favorable shocks. Yet if this real appreciation is very dramatic, or the adjustment process towards the new equilibrium is uneven (i.e. not fully consistent with the change in economic fundamentals at each point in time) policy makers may wish to mitigate, to the extent possible, its adverse effects on export industries.

In principle, one could also mention two additional reasons of concern for policy makers that are usually mentioned in the context of surges of capital inflows. One is the potential for a flow reversal over the medium run. This is important because if there is hysteresis in the real sector, a real exchange rate appreciation may wipe out important sectors of the economy that would not reappear even if the currency subsequently depreciates. The other potential concern is a very sudden appreciation that cannot be accommodated and therefore brings a very painful adjustment. However, it must be noted that the documented stability<sup>5</sup> and counter-cyclicality of remittances would lead one to assume that the probability of short-run reversals or sudden adjustments is quite low, leaving as main reason for concern the magnitude of the real appreciation associated to the remittance inflows.

Against this background, what does the economics literature have to say about the evolution of the exchange rate in countries that have experienced important increases of remittances? The truth is that the existing empirical literature is very limited and less than unanimous. For example, Amuedo-Dorantes and Pozo (2004) rely on cross country econometrics techniques and find that in a sample of 13 Latin American countries<sup>6</sup> a doubling of workers remittances would lead on average to a real exchange rate overvaluation of about 22 percent. This estimate would be robust to the presence of fixed effects in the data, and to the use of IV estimation techniques to account for reverse causality from the exchange rate to remittances.

However, Rajan and Subramanian (2005), who rely on a cross national dataset of 3-digit industry value added growth data to explore whether remittances have a differential impact depending on the labor intensity of the different industries, find that unlike other types of capital flows (particularly aid flows) remittances do not seem to have a negative impact on external competitiveness. Rajan and Subramanian (2005) argue that this could be the result of remittances being directed to a large extent towards unskilled-labor intensive activities – e.g. goods and services provided by micro-enterprises – and/or tradable sectors such as manufacturing, and thus having limited effects on the prices of skilled labor and other relatively scarce resources.

> 5 The stability of remittances over time is one of the most important differences between remittances and other types of capital inflows. In fact, as noted by the _Word Economic Outlook 2005_ , non-FDI private capital flows, exports, FDI, and even official aid all show greater volatility than remittances.

> 6 The countries in their sample are: Argentina, Belize, Bolivia, Colombia, Dominican Republic, El Salvador, Guatemala, Honduras, Jamaica, Mexico, Nicaragua, Peru, and Trinidad & Tobago.

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