Price and trade effects of exchange rate fluctuations and the design of policy coordination
We analyze a two-country zone facing a joint inflationary shock and responding with coordinated and uncoordinated monetary and fiscal policies. We show that the standard presumption that the absence of coordination results in an excessive exchange rate appreciation of the zone with respect to the rest of the world hinges on a specific assumption: that within the two countries considered, the price effect of exchange rate fluctuations dominates the trade effects relatively to the corresponding effects vis-a-vis the rest of the world. If the relative hierarchy goes the other way around (as we argue is likely for EC countries), the standard conclusion is reversed, resulting in insufficiently active monetary and fiscal policies. The paper considers asymmetric shocks as well as monetary policy coordination.
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- Cohen, Daniel & Wyplosz, Charles, 1989. "The European Monetary Union: An Agnostic Evaluation," CEPR Discussion Papers 306, C.E.P.R. Discussion Papers.
- Marcus Miller & Mark Salmon, 1985. "Policy Coordination and Dynamic Games," NBER Chapters, in: International Economic Policy Coordination, pages 184-227 National Bureau of Economic Research, Inc.
- Jeffrey Sachs, 1983. "International Policy Coordination in a Dynamic Macroeconomic Model," NBER Working Papers 1166, National Bureau of Economic Research, Inc.
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