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Price Rigidity and the Selection of the Exchange Rate Regime

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  • Fabrice Collard
  • Harris Dellas

Abstract

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

Suggested Citation

  • Fabrice Collard & Harris Dellas, 2006. "Price Rigidity and the Selection of the Exchange Rate Regime," Open Economies Review, Springer, vol. 17(1), pages 5-26, January.
    • Handle: RePEc:kap:openec:v:17:y:2006:i:1:p:5-26
    DOI: 10.1007/s11079-006-5212-3
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    References listed on IDEAS

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    1. Marvin Goodfriend & Robert G. 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.
    2. 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.
    3. V. V Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2002. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 69(3), pages 533-563.
    4. Obstfeld, Maurice & Rogoff, Kenneth, 2000. "New directions for stochastic open economy models," Journal of International Economics, Elsevier, vol. 50(1), pages 117-153, February.
    5. Collard, Fabrice & Dellas, Harris, 2002. "Exchange rate systems and macroeconomic stability," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 571-599, April.
    6. 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.
    7. Kollmann, Robert, 2002. "Monetary policy rules in the open economy: effects on welfare and business cycles," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 989-1015, July.
    8. Dellas, Harris, 2006. "Monetary policy in open economies," European Economic Review, Elsevier, vol. 50(6), pages 1471-1486, August.
    9. 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.
    10. 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.
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    Cited by:

    1. Collard, Fabrice & Dellas, Harris, 2006. "The case for inflation stability," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 1801-1814, November.
    2. Philippopoulos, Apostolis & Varthalitis, Petros & Vassilatos, Vanghelis, 2017. "Fiscal consolidation and its cross-country effects," Journal of Economic Dynamics and Control, Elsevier, vol. 83(C), pages 55-106.
    3. Jorge Carrera & Diego Bastourre, 2004. "Could the Exchange Rate Regime Reduce Macroeconomic Volatility?," Econometric Society 2004 Latin American Meetings 309, Econometric Society.
    4. Hyuk Jae Rhee & Jeongseok Song, 2017. "Real Wage Flexibility, Economic Fluctuations, and Exchange Rate Regimes," Open Economies Review, Springer, vol. 28(4), pages 633-659, September.
    5. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2017. "Fiscal Consolidation in an Open Economy with Sovereign Premia and without Monetary Policy Independence," International Journal of Central Banking, International Journal of Central Banking, vol. 13(4), pages 259-306, December.
    6. George Economides & Apostolis Philippopoulos & Petros Varthalitis, 2016. "Monetary Union, Even Higher Integration, or Back to National Currencies?," CESifo Economic Studies, CESifo, vol. 62(2), pages 232-255.
    7. Harris Dellas, 2003. "Monetary Policy in Open Economies under Imperfect Information," Working Papers 072003, Hong Kong Institute for Monetary Research.
    8. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2013. "Optimal Fiscal Action in an Economy with Sovereign Premia and without Monetary Independence: An Application to Italy," CESifo Working Paper Series 4199, CESifo.
    9. Patrick Minford & Prakriti Sofat, 2004. "An Open Economy Real Business Cycle Model for the UK," Money Macro and Finance (MMF) Research Group Conference 2004 23, Money Macro and Finance Research Group.

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