The resource reallocation costs of fixed and flexible exchange rates: A multi-country extension

For a sample of nineteen countries for 1972–79 we test the hypothesis that reallocation costs associated with temporary disturbances to the export sector of an economy are equal under fixed and flexible exchange rates. This test is an extension of earlier work indicating that in the special case of Canada, reallocation costs do not differ significantly under fixed and flexible rates. The degree of industrialization and openness of the countries included in the sample varies greatly; so it is interesting that the Canadian result generalizes to all but two cases. These results suggest that even during periods of considerable exchange rate variability, unnecessary resource reallocation costs may not be a significant disadvantage of a flexible exchange-rate system.     

The resource reallocation costs of fixed and flexible exchange rates: A counterexample

This paper questions the view that resource reallocation costs are a disadvantage of a flexible exchange rate system relative to a fixed exchange rate. It is shown that reallocation costs of a flexible exchange rate are not necessarily greater than and indeed may be less than, those under a fixed exchange rate. A method is developed for testing this hypothesis. Applying the technique to Canadian exchange rate policy for 1953–1977 provides a counterexample to the view that reallocation costs are a disadvantage of flexible exchange rates.     

Real effects of collapsing exchange rate regimes: an application to Mexico

This paper examines the impact of collapsing fixed, permanently fixed, and flexible exchange rate regimes on real output. Much of the recent discussion of the causes of exchange rate regime collapses has focused on capital flows and export demands. In an environment in which such external shocks predominate, a flexible exchange rate is shown theoretically to produce lower output variability for a range of parameter values. A counterfactual exercise is performed using Mexican data. We find that had Mexico been on a flexible rate for the past two decades, the variance of real output would have been reduced by half.     

Segmented asset markets and optimal exchange rate regimes

This paper revisits the issue of the optimal exchange rate regime in a flexible price environment. The key innovation is that we analyze this question in the context of environments where only a fraction of agents participate in asset market transactions (i.e., asset markets are segmented). Under this friction alternative exchange rate regimes have different implications for real allocations in the economy. In the context of this environment we show that flexible exchange rates are optimal under monetary shocks and fixed exchange rates are optimal under real shocks.     

Currency substitution,money growth rules,and the interdependence of monetary policy

This paper examines the interdependence of national monetary policies under flexible exchange rates when national currencies are seen as substitutes for one another. It is shown that the efficacy of a constant monetary growth rule as a means of controlling a country's price level depends on the policies of foreign central banks. These results are in contrast to those found under flexible exchange rates and no currency substitution. The role of monetary growth rules in a world of currency substitution is discussed.     

On the Link Between Exchange‐rate Regimes,Capital Controls and Monetary Policy Autonomy in Small European Countries, 1979–2000

We investigate international monetary‐policy transmission under different exchange‐rate and capital‐account regimes in eleven small, open economies during the 1980s and 1990s. We find no systematic link between ex‐post monetary‐policy autonomy and exchange‐rate regimes. Capital controls appear to have provided a degree of temporal insulation from foreign monetary policy shocks, though not strict autonomy. The results are consistent both with short‐term autonomy for small countries even under fixed exchange rates and an open capital account, and with long‐term dependence under flexible exchange rates and an independent stability target. Results also indicate that euro‐area market interest rates are significantly more responsive to the development of the corresponding US rate than were the previous national rates.     

A Discrete‐Time Intertemporal Asset Pricing Model: GE Approach with Recursive Utility

This paper studies the equilibrium characterization of asset pricing in a discrete‐time Lucas exchange economy (Lucas 1978) with the intertemporal recursive utility function of Epstein and Zin (1989). A general formulation of equilibrium asset pricing is presented. It is shown that risk aversion of a certainty equivalent corresponds to risk aversion in the intertemporal asset pricing model. The discrete‐time analogue of Ma's (1993) option pricing formula is derived in an i.i.d. environment, with which we prove an observational nonequivalence theorem in distinguishing the differences of the betweenness recursive utility functions and the expected utility functions. Additionally, when the consumption growth rate follows a first-order Markov process, it is shown that the observational nonequivalence result holds for Kreps–Porteus expected utility. Finally, as by-products, this paper also contains derivations of closed-form formulas for the aggregate equity (with endogenously determined yields), the term structure of interest rates, and European call options on the aggregate equity in a Markov setting.     

VARIABLE MARKUP IN A SMALL OPEN ECONOMY WITH INFLATION

This paper analyzes markup disturbances in a small open economy with flexible exchange rates and secular inflation. Specifically, I assume that the private sector fully controls a variable markup over costs. The markup is shown to vary (pro)anticyclically depending on the magnitude of the initial jump in the exchange rate following the disturbance.     

A dynamic model of tariffs,output and employment under flexible exchange rates

A portfolio balance model of the open economy with imperfectly flexible wages and rational expectations is used to analyze the macroeconomic effects of commercial policy. Previous analyses have led to the ‘counterintuitive’ and ‘almost inconceivable’ conclusion that, under flexible exchange rates, a tariff is contractionary. By considering a tariff in a dynamic setting and focusing on the process of adjustment, it is shown that there may exist a tradeoff between a tariffs short-run and long-run effects. In certain circumstances, a tariff imposed under flexible exchange rates increases output and employment initially while reducing them subsequently.     

Foreign monetary shocks,differentiated products and international transmission: a two-country model with intra-industry trade

In this paper we study how the impact of a foreign monetary shock is transmitted between two monopolistically competitive economies engaging in intra-industry trade with differentiated products. Intra-industry trade is the only international link that works through the flexible exchange rate affecting national price levels and a product's internal and external relative prices. While national price levels are subject to purchasing power parity, the two relative prices are determined by the interaction between macro and micro variables. In this context, the exchange rate can insulate a national economy perfectly from a foreign monetary shock provided that monopolists adjust prices. Even if monopolists keep prices rigid, this shock only affects domestic real balances and aggregate demand, leaving domestic aggregate output unchanged because the real balances effect is just offset by the resulting unfavorable relative prices effects under the assumption of Spence-Dixit-Stiglitz preferences.     

Twenty years of flexible exchange rates: Experiences and developments

The Bretton Woods system of fixed exchange rates was abandoned at the beginning of March 1973 when currencies were allowed to float. Has the system of flexible exchange rates fulfilled the expectations placed in it? How should experiences with regional systems of fixed exchange rates be assessed, and what are the prospects for a return to such a system worldwide?     

The impact of exchange rate regimes on economic growth: Empirical study of a set of developing countries during the period 1974–2006

An increment in the quantity of services/goods manufactured per-head of the population over time denotes economic growth of a country. Exchange Rate Intermediate Regimes are unable to continue under conditions of capital movement. To examine the relationship between exchange rate regimes and economic growth. This study has kept its focus on the economic growth of a set of developing countries during the years (1974–2006). Fixed effects and pooled regression for 16 developing countries have been incorporated as the methodologies techniques for data. Analysis of data was performed through SPSS. A relationship between exchange rate regimes and economic growth has been identified through statistical approaches. The results indicated that as compared to flexible exchange regime, growth rate was higher by 1.2% when fixed exchange regime was adopted; and a growth rate of 0.64% was achieved under the intermediate regime when compared with the flexible regime. A positive impact has been identified in exchange rate regimes upon economic growth of the developing countries. Countries following the flexible exchange rates are facing scarcity for the existence of advanced financial systems, which deprives them of enjoying the benefits of flexible regime.     

Currency mismatches and monetary policy: A tale of two equilibria

We develop a model of a small economy whose residents choose whether to borrow in domestic or foreign currency. The central bank, in turn, chooses fixed or flexible exchange rates, taking the currency denomination of debts as given. We characterize the simultaneous determination of portfolios and exchange rate regime. Both floating and fixed rates can occur as equilibrium outcomes. “Fear of floating” may emerge endogenously and in association with a currency mismatch in assets and liabilities. If equilibria with both fixed rates and floating rates coexist, the latter is Pareto superior. Lessons for current “de-dollarization” proposals are discussed.     

Flexible exchange rates,unemployment and stabilization policy effectiveness

The paper presents a general equilibrium model of a small flexible exchange rate economy comprising asset, goods, and labor markets. Viewing the exchange rate as determined proximately in asset markets, the study examines its influence on the excess demand for labor and for output and, correspondingly, its impact on the level of unemployment and external imbalance. The role of exchange rate expectations is central to the present analysis, which reconsiders, in that light, the conventional conclusions about monetary and fiscal policy effectiveness under flexible exchange rates.     

The role of elasticity optimism in choosing an optimal currency basket with applications to Israel

In a world in which exchange rates are floating each country must have some device for measuring the average exchange rate change, whatever exchange rate policy it chooses. The weight for each currency in computing such an average depends on the objective which exchange rate stabilization, or change, is expected to achieve. If balance of trade stability is the desideratum, the optimum weights (optimum currency basket) are shown to be a function of demand elasticities, GNP, trade shares, etc. We derive a loss function measuring the cost of using a ‘wrong’ basket, and compute the value of this function for our ‘optimal’ Israeli basket as a case study.     

The dynamics of exchange rate regimes: Fixes, floats, and flips

The impermanence of fixed exchange rates has become a stylized fact in international finance. The combination of the “mirage” view that pegs do not really peg with the “fear of floating” view that floats do not really float generates the conclusion that exchange rate regimes are, in practice, unimportant for the behavior of the exchange rate. This is consistent with evidence on the irrelevance of exchange rate regimes for general macroeconomic performance. Recent studies, however, show that the exchange rate regime matters. This can be understood by considering the dynamics of exchange rate regimes. We demonstrate that the “mirage” view is somewhat misleading and incomplete. Pegs frequently break, but many do last. Also, there is a high degree of flipping, that is, the re-formation of pegs that have broken. Thus, a fixed exchange rate today is a good predictor that one will exist in the future. We also investigate the quantitative effect of fixed exchange rates. While the “fear of floating” view suggests little actual difference in fixed and floating rates with respect to exchange rate volatility, we show that fixed exchange rates exhibit considerably greater bilateral exchange rate stability than flexible rates, both today and in the future.     

Target zones for the US dollar?

The discussion of target zones for flexible exchange rates is evidence of the desire to experiment with new instruments for stabilising the international monetary system. What distinguishes target zones from systems of flexible and fixed exchange rates? What form should they take? How should one regard the various objections to target zones?     

Some doubts about the efficacy of monetary policy under flexible exchange rates

This paper raises doubts about the proposition that monetary policy is effective, under flexible exchange rates, in stabilizing domestic output. It is argued that if the price elasticities of the demands for exports and imports are affected by the transition to flexible rates, and capital flows are assumed to be dependent on the exchange rate, the efficacy of monetary policy under flexible rates will not necessarily follow.     

Exchange rate versus inflation targeting: a theory of output fluctuations in traded and non-traded sectors

This paper develops a basic model for output fluctuations in traded and non-traded sectors under two alternative monetary policy regimes; exchange rate targeting (or monetary union) and inflation targeting. The conventional wisdom from one-sector models says that inflation targeting gives better output stabilization than exchange rate targeting when demand shocks occur, but the opposite when supply shocks occur. In a model with a traded and a non-traded sector, we show that the conventional wisdom holds for the non-traded sector. However, for the traded sector, we show that inflation targeting destabilizes output compared with exchange rate targeting when both supply and demand shocks occur. The only shocks where inflation targeting provides the better output stability for the traded sector are shocks to world market prices. The two-sector structure introduces new mechanisms that may turn around earlier results for aggregate production. For instance, a demand shock may induce higher aggregate output fluctuations with inflation targeting than with exchange rate targeting. Furthermore, a positive demand shock may prove to be contractionary under inflation targeting.