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The Devil you Know: Pegs vs Floats with Uncertain Outcomes

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  • Menna Bizuneh
  • Neven Valev

Abstract

Theory predicts that a fixed exchange rate regime will be abandoned after a sizable economic shock as currency devaluation could stimulate exports and output. However, devaluation is risky as the new level of the exchange rate and the rate of inflation cannot be predicted. We show that this uncertainty creates resistance to devaluation. Policymakers prefer to maintain the fixed exchange rate and to undergo internal adjustment. We illustrate the point theoretically and provide supporting evidence from Bulgaria's currency board.

Suggested Citation

  • Menna Bizuneh & Neven Valev, 2014. "The Devil you Know: Pegs vs Floats with Uncertain Outcomes," Review of International Economics, Wiley Blackwell, vol. 22(4), pages 686-699, September.
    • Handle: RePEc:bla:reviec:v:22:y:2014:i:4:p:686-699
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    References listed on IDEAS

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