The paper takes issue with the proposition that a fixed exchange rate regime reduces the ability of the economy to adjust to outside macroeconomic shocks, even in a world where prices are sticky. We construct a model where a very small economy interacts with a large world economy, and must choose an exchange rate policy to deal with macro shocks coming from the rest of the world. We show that there is in fact no trade-off between exchange rate flexibility and output volatility. In fact, in face of monetary disturbances coming from the rest of the world, output volatility is lower under fixed exchange rates than under floating exchange rates.
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Paper provided by UBC Department of Economics in its series UBC Departmental Archives with number
99-06.
Find related papers by JEL classification: F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
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