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Does Exchange Rate Variability Matter for Welfare? A Quantitative Investigation of Stabilization Policies

  • Paul Bergin
  • Hyung-Cheol Shin
  • Ivan Tchakarov

    (Department of Economics, University of California Davis)

This paper evaluates quantitatively the potential welfare gains from monetary policy and fixed exchange rate rules in a two-country sticky-price model. The first finding is that the gains from stabilization tend to be small in the types of economic environments emphasized in recent theoretical literature. The analysis goes on to identify two types of economies in which the welfare implications of risk are larger: where agents exhibit habits, and where international asset markets exhibit asymmetry in the form of “original sin.” In the habits case, monetary policy aimed solely at inflation stabilization is optimal. But in the original sin case there are potentially large welfare gains from also eliminating exchange rate volatility.

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Paper provided by University of California, Davis, Department of Economics in its series Working Papers with number 512.

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Length: 28
Date of creation: 30 Jun 2005
Date of revision:
Handle: RePEc:cda:wpaper:05-12
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  1. Schmitt-Grohe, Stephanie & Uribe, Martin, 2007. "Optimal simple and implementable monetary and fiscal rules," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1702-1725, September.
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  4. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1997. "Sticky price and limited participation models of money: A comparison," European Economic Review, Elsevier, vol. 41(6), pages 1201-1249, June.
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  9. Sutherland, Alan, 2005. "Incomplete pass-through and the welfare effects of exchange rate variability," Journal of International Economics, Elsevier, vol. 65(2), pages 375-399, March.
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  11. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
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  14. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
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  18. Christopher A. Sims & Jinill Kim & Sunghyun Kim, 2004. "Calculating and Using Second Order Accurate Solution of Discrete Time Dynamic Equilibrium Models," Econometric Society 2004 North American Winter Meetings 411, Econometric Society.
  19. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 743-764.
  20. Bergin, Paul R., 2003. "Putting the 'New Open Economy Macroeconomics' to a test," Journal of International Economics, Elsevier, vol. 60(1), pages 3-34, May.
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