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The Optimal Choice of Exchange Rate Regime: Price-Setting Rules and Internationalized Production

In: Topics in Empirical International Economics: A Festschrift in Honor of Robert E. Lipsey

  • Michael B. Devereux
  • Charles Engel

We investigate the choice of exchange-rate regime fixed or floating in a dynamic, intertemporal general equilibrium framework. Our framework extends Devereux and Engel (1998) by investigating the implications of internationalized production. We examine the role of price-setting -- whether prices are set in the currency of producers or the currency of consumers in determining the optimality of exchange-rate regimes in an environment of uncertainty created by monetary shocks. We find that when prices are set in producers' currencies, floating exchange rates are preferred when the country is large enough, or not too risk averse. On the other hand, floating exchange rates are always preferred when prices are set in consumers' currencies because floating exchange rates allow domestic consumption to be insulated from foreign monetary shocks. The gains from floating exchange rates are greater when there is internationalized production in this case.

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This chapter was published in:
  • Magnus Blomstrom & Linda S. Goldberg, 2001. "Topics in Empirical International Economics: A Festschrift in Honor of Robert E. Lipsey," NBER Books, National Bureau of Economic Research, Inc, number blom01-1.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 10582.
    Handle: RePEc:nbr:nberch:10582
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