An ability to adequately assess the functioning of exchange rate regimes is crucial. Such an assessment will be based on a priori beliefs about how different regimes react to shocks and therefore which regime will be appropriate for a given economy. This paper contributes to this literature by examining how a wide variety of potential exchange rate regimes operate in the face of demand and supply shocks. The results show that the choice of exchange rate regime can significantly affect the transmission mechanism, particularly for supply shocks. This therefore has important implications for any methodology which uses VAR decompositions to judge the compatibility of economies to participate in fixed exchange rate regimes. In particular, when preexisting differences in exchange rate regimes are not accounted for, the results may be highly misleading. The constraint that policies are time consistent plays a significant role in determining the welfare costs associated with different regimes, particularly for supply shocks where a free float no longer dominates possible alternatives. Another important aspect is the degree of nominal inertia, which has a strong bearing on the costs associated with each regime. In particular, the reduction in the welfare loss if nominal inertia falls is significantly greater for EMU.
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Publisher Info
Paper provided by University of Exeter, School of Business and Economics in its series Discussion Papers with number
00/03.
Length: 48 pages Date of creation: 2000 Date of revision: Handle: RePEc:fth:exetec:00/03
Contact details of provider: Postal: School of Business and Economics University of Exeter Streatham Court Rennes Drive Exeter EX4 4PU Phone: (01392) 263218 Fax: (01392) 263242 Web page: http://www.exeter.ac.uk/sobe/ More information through EDIRC
Find related papers by JEL classification: F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
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