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The Optimal Choice of Exchange-Rate Regime: Price-Setting Rules and Internationalized Production

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Michael B. Devereux
Charles Engel

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Abstract

We investigate the choice of exchange-rate regime fixed or floating in a dynamic, intertemporal general equilibrium framework. Our framework extends Devereux and Engel (1998) by investigating the implications of internationalized production. We examine the role of price-setting -- whether prices are set in the currency of producers or the currency of consumers in determining the optimality of exchange-rate regimes in an environment of uncertainty created by monetary shocks. We find that when prices are set in producers' currencies, floating exchange rates are preferred when the country is large enough, or not too risk averse. On the other hand, floating exchange rates are always preferred when prices are set in consumers' currencies because floating exchange rates allow domestic consumption to be insulated from foreign monetary shocks. The gains from floating exchange rates are greater when there is internationalized production in this case.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6992.

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Date of creation: Mar 1999
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Publication status: published as Topics in Empirical International Economics: Festschrift in Honor of Robert Lipsey, Blomstrom, Magnus and Linda Goldberg, eds., Chicago: University of Chicago Press and NBER.
Handle: RePEc:nbr:nberwo:6992

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F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General
F20 - International Economics - - International Factor Movements and International Business - - - General

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Alexander Mihailov, 2003. "Effects of the Exchange-Rate Regime on Trade under Monetary Uncertainty: The Role of Price Setting," Economics Discussion Papers 566, University of Essex, Department of Economics. [Downloadable!]
  2. Dehejia, Vivek & Rowe, Nicholas, 2000. "Macroeconomic Stabilization: Fixed Exchange Rates Vs Inflation Targeting Vs Price Level Targeting," CEPR Discussion Papers 2460, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  3. Ugo Gasparino & Elena Bellini & Barbara Del Corpo & William Malizia, 2008. "Measuring the Impact of Tourism Upon Urban Economies: A Review of Literature," Working Papers 2008.52, Fondazione Eni Enrico Mattei. [Downloadable!]
  4. Maurice Obstfeld & Kenneth Rogoff, 1999. "New Directions for Stochastic Open Economy Models," NBER Working Papers 7313, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Jorge Selaive & Vincente Tuesta, 2003. "Net foreign assets and imperfect pass-through: the consumption real exchange rate anomaly," International Finance Discussion Papers 764, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  6. Alexander Mihailov, 2003. "When and How Much Does a Peg Increase Trade? The Role of Trade Costs and Import Demand Elasticity under Monetary Uncertainty," Economics Discussion Papers 567, University of Essex, Department of Economics. [Downloadable!]
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  7. William P. Killeen & Richard K. Lyons & Michael J. Moore, 2001. "Fixed versus Flexible: Lessons from EMS Order Flow," NBER Working Papers 8491, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Elena Bellini & Ugo Gasparino & Barbara Del Corpo & William Malizia, 2007. "Impact of Cultural Tourism upon Urban Economies: An Econometric Exercise," Working Papers 2007.85, Fondazione Eni Enrico Mattei. [Downloadable!]
  9. Lilia Cavallari, 2004. "Optimal monetary rules and internationalized production," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 9(2), pages 175-186. [Downloadable!]
  10. Kevin X.D. Huang & Zheng Liu, 2005. "Vertical production and trade interdependence and welfare," Working Papers 05-15, Federal Reserve Bank of Philadelphia. [Downloadable!]
  11. Kevin X.D. Huang & Zheng Liu, 2004. "Production interdependence and welfare," Working Paper Series 355, European Central Bank. [Downloadable!]
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