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The Benefit of Exchange Rate Flexibility, Trade Openness and Extensive Margin

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  • Kanda Naknoi

Abstract

The literature on optimum currency areas argues that in the presence of countryspecific real shocks, the cost of fixing exchange rates is decreasing in the degree of trade openness. This study uses a stochastic dynamic general equilibrium model of endogenous specialization to assess the benefit of exchange rate flexibility. The benefit of exchange rate flexibility consists of the benefit along the extensive margin through adjustment in the composition of trade, and the benefit along the intensive margin through adjustment in the relative prices. Openness is found to influence these two benefits differently. Thus, the model predicts a non-monotonic relationship between openness and the benefit of exchange rate flexibility.

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Bibliographic Info

Paper provided by Purdue University, Department of Economics in its series Purdue University Economics Working Papers with number 1215.

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Length: 30 pages
Date of creation: Nov 2008
Date of revision:
Handle: RePEc:pur:prukra:1215

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Keywords: Exchange rate regimes; Trade costs; Openness;

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Cited by:
  1. Masashige Hamano & Pierre M. Picard, 2013. "Extensive and intensive margins and the choice of exchange rate regimes," CREA Discussion Paper Series 13-18, Center for Research in Economic Analysis, University of Luxembourg.

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