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Price Rigidity and the Selection of the Exchange Rate Regime

  • Fabrice Collard

    ()

  • Harris Dellas

    ()

We evaluate and qualify Friedman's, 1953, “case for flexible exchange rates†in the presence of sticky prices in a two country model. We find that a flexible regime performs indeed better when the degree of nominal price rigidity is high while a bilateral peg does better when prices are fairly flexible. This result obtains independent of whether monetary policy is activistic or not and is mostly due to the negative relationship between employment and productivity shocks when prices are relatively sluggish (Gali, 1999). A unilateral peg tends to produce the lowest level of world welfare but it sometimes represents the best monetary arrangement for the pegger. Copyright Springer Science + Business Media, Inc. 2006

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File URL: http://hdl.handle.net/10.1007/s11079-006-5212-3
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Article provided by Springer in its journal Open Economies Review.

Volume (Year): 17 (2006)
Issue (Month): 1 (January)
Pages: 5-26

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Handle: RePEc:kap:openec:v:17:y:2006:i:1:p:5-26
Contact details of provider: Web page: http://www.springerlink.com/link.asp?id=100323

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  1. Maurice Obstfeld & Kenneth Rogoff, 2000. "New Directions for Stochastic Open Economy Models," International Finance 0004002, EconWPA.
  2. Marvin Goodfriend & Robert King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296 National Bureau of Economic Research, Inc.
  3. David Backus & Patrick J. Kehoe & Finn E. Kydland, 1993. "International Business Cycles: Theory and Evidence," NBER Working Papers 4493, National Bureau of Economic Research, Inc.
  4. John B. Taylor, 2001. "The Role of the Exchange Rate in Monetary-Policy Rules," American Economic Review, American Economic Association, vol. 91(2), pages 263-267, May.
  5. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
  6. Collard, Fabrice & Dellas, Harris, 2002. "Exchange rate systems and macroeconomic stability," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 571-599, April.
  7. Robert Kollmann, 2002. "Monetary policy rules in the open economy: effects of welfare and business cycles," ULB Institutional Repository 2013/7628, ULB -- Universite Libre de Bruxelles.
  8. V. V Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2002. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," Review of Economic Studies, Oxford University Press, vol. 69(3), pages 533-563.
  9. Dellas, Harris, 2006. "Monetary policy in open economies," European Economic Review, Elsevier, vol. 50(6), pages 1471-1486, August.
  10. Pappa, Evi, 2004. "Do the ECB and the fed really need to cooperate? Optimal monetary policy in a two-country world," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 753-779, May.
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