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Exchange rate risks in a small open economy

Author

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  • Chikafumi Nakamura

Abstract

Purpose - This study aims to analyze exchange rate risks and the choice of exchange rate policies in a small open economy indebted in foreign currency, incorporating the financial accelerator mechanism. Design/methodology/approach - To examine discussions on the fear of floating, this study develops a dynamic stochastic general equilibrium model in which a small open economy model has an open economy financial accelerator mechanism as the external borrowing restriction. The author then compares and analyzes the macroeconomic dynamics in response to an exchange rate shock under different exchange rate systems. Findings - The most interesting finding is that the currency peg for a foreign currency used in borrowing is more efficient than the trade-weighted currency basket policy, regardless of trade openness or trade share. Practical implications - The result implies that in discussions on the fear of floating, more attention needs to be paid to exchange rate risks in finance. It also suggests that exchange rate policy used to mitigate exchange rate risks in finance stabilizes macroeconomic volatility more efficiently. Originality/value - The paper provides an answer to the question: which is the more serious problem in the fear of floating and to what would the regime be anchored.

Suggested Citation

  • Chikafumi Nakamura, 2016. "Exchange rate risks in a small open economy," Journal of Financial Economic Policy, Emerald Group Publishing Limited, vol. 8(3), pages 348-363, August.
    • Handle: RePEc:eme:jfeppp:v:8:y:2016:i:3:p:348-363
    DOI: 10.1108/JFEP-10-2015-0060
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    Citations

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    Cited by:

    1. Mance, Davor & Olgic Drazenovic, Bojana & Suljic Nikolaj, Stella, 2019. "Croatian Kuna: Money, Or Just A Currency? Evidence From The Interbank Market," UTMS Journal of Economics, University of Tourism and Management, Skopje, Macedonia, vol. 10(2), pages 149-161.
    2. Montes, Gabriel Caldas & Ferreira, Caio Ferrari, 2020. "Does monetary policy credibility mitigate the fear of floating?," Economic Modelling, Elsevier, vol. 84(C), pages 76-87.

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