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Price Rigidity and the Selection of the Exchange Rate Regime

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  • Fabrice Collard

    ()

  • Harris Dellas

    ()

Abstract

We evaluate and qualify Friedman's, 1953, “case for flexible exchange rates†in the presence of sticky prices in a two country model. We find that a flexible regime performs indeed better when the degree of nominal price rigidity is high while a bilateral peg does better when prices are fairly flexible. This result obtains independent of whether monetary policy is activistic or not and is mostly due to the negative relationship between employment and productivity shocks when prices are relatively sluggish (Gali, 1999). A unilateral peg tends to produce the lowest level of world welfare but it sometimes represents the best monetary arrangement for the pegger. Copyright Springer Science + Business Media, Inc. 2006

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File URL: http://hdl.handle.net/10.1007/s11079-006-5212-3
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Bibliographic Info

Article provided by Springer in its journal Open Economies Review.

Volume (Year): 17 (2006)
Issue (Month): 1 (January)
Pages: 5-26

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Handle: RePEc:kap:openec:v:17:y:2006:i:1:p:5-26

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Web page: http://www.springerlink.com/link.asp?id=100323

Related research

Keywords: exchange rate systems; monetary policy; price sluggishness; inflation targeting;

References

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  1. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  2. Maurice Obstfeld & Kenneth Rogoff, 1999. "New Directions for Stochastic Open Economy Models," NBER Working Papers 7313, National Bureau of Economic Research, Inc.
  3. Kollmann, Robert, 2002. "Monetary Policy Rules in the Open Economy: Effects on Welfare and Business Cycles," CEPR Discussion Papers 3279, C.E.P.R. Discussion Papers.
  4. V. V Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2002. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," Review of Economic Studies, Oxford University Press, vol. 69(3), pages 533-563.
  5. John B. Taylor, 2001. "The Role of the Exchange Rate in Monetary-Policy Rules," American Economic Review, American Economic Association, vol. 91(2), pages 263-267, May.
  6. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1993. "International Business Cycles: Theory and Evidence," Working Papers 93-21, New York University, Leonard N. Stern School of Business, Department of Economics.
  7. Dellas, Harris, 2006. "Monetary policy in open economies," European Economic Review, Elsevier, vol. 50(6), pages 1471-1486, August.
  8. Collard, Fabrice & Dellas, Harris, 2002. "Exchange rate systems and macroeconomic stability," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 571-599, April.
  9. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
  10. Pappa, Evi, 2004. "Do the ECB and the fed really need to cooperate? Optimal monetary policy in a two-country world," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 753-779, May.
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Citations

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Cited by:
  1. Harris Dellas, 2003. "Monetary Policy in Open Economies under Imperfect Information," Working Papers 072003, Hong Kong Institute for Monetary Research.
  2. Collard, Fabrice & Dellas, Harris, 2003. "The Case for Inflation Stability," CEPR Discussion Papers 4082, C.E.P.R. Discussion Papers.
  3. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2013. "Optimal Fiscal Action in an Economy with Sovereign Premia and without Monetary Independence: An Application to Italy," CESifo Working Paper Series 4199, CESifo Group Munich.
  4. Diego Bastourre & Jorge Carrera, 2004. "Could The Exchange Rate Regime Reduce Macroeconomic Volatility?," Anais do XXXII Encontro Nacional de Economia [Proceedings of the 32th Brazilian Economics Meeting] 067, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
  5. Patrick Minford & Prakriti Sofat, 2004. "An Open Economy Real Business Cycle Model for the UK," Money Macro and Finance (MMF) Research Group Conference 2004 23, Money Macro and Finance Research Group.

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