Endogeneity of the Optimal Currency Area Revisited
AbstractBy fixing the exchange rate, a country rules out the possibility of using the exchange rate to adjust to aggregate demand shocks. But adjustment may be enhanced if internal prices are more flexible. This paper asks whether this increase in price flexibility is likely to take place endogenously after an an exchange rate peg. We find that the answer is yes in the case of an unilateral peg followed by one country alone. On the other hand, when an exchange rate peg is supported by bilateral participation of both monetary authorities, the degree of price flexibility may actually be less than under freely floating exchange rates. Finally, our model allows for multiple, self-fulfilling equilibria in the degree of price flexibility. In that case, a peg may cause a dramatic increase in the flexibility of prices.
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Bibliographic InfoPaper provided by Econometric Society in its series Econometric Society 2004 North American Winter Meetings with number 630.
Date of creation: 11 Aug 2004
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exchange rates; self-fulfilling equilibria;
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- F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General
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