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Does Exchange Rate Variability Matter for Welfare? A Quantitative Investigation of Stabilization Policies

Author

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  • Paul Bergin
  • Hyung-Cheol Shin
  • Ivan Tchakarov

    (Department of Economics, University of California Davis)

Abstract

This paper evaluates quantitatively the potential welfare gains from monetary policy and fixedexchange rate rules in a two-country sticky-price model. The first finding is that the gains fromstabilization tend to be small in the types of economic environments emphasized in recenttheoretical literature. The analysis goes on to identify two types of economies in which thewelfare implications of risk are larger: where agents exhibit habits, and where international assetmarkets exhibit asymmetry in the form of ?original sin.? In the habits case, monetary policyaimed solely at inflation stabilization is optimal. But in the original sin case there are potentiallylarge welfare gains from also eliminating exchange rate volatility.

Suggested Citation

  • Paul Bergin & Hyung-Cheol Shin & Ivan Tchakarov, 2005. "Does Exchange Rate Variability Matter for Welfare? A Quantitative Investigation of Stabilization Policies," Working Papers 265, University of California, Davis, Department of Economics.
    • Handle: RePEc:cda:wpaper:265
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    More about this item

    Keywords

    exchange rate risk; second order approximation;

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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