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Optimal exchange rate regime in a two-sector economy

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  • Wibaut, Quentin

    (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))

Abstract

The present article deals with the issue of optimal degree of exchange rate flexibility. It departs from the current literature on the subject as it does not introduce nominal rigidities nor address the question of international monetary cooperation. Instead, the argument hinges on the economic structure of the economy. The existence of sectorial strategic interactions yields a welfare improving opportunity of coordination for monetary policy. Monetary policy can act as a weak-coordinating device by reducing the market power of the price setting agent. This is possible by linking the non-cooperative agents' decision to money supply (through a monetary rule). The smaller a sector, the larger its ability to set a high relative price without having to bear the bad consequences of it. As a result, the monetary rule must be more restrictive vis-à-vis small sectors. In a very open economy, that is, when the non-tradable sector is small, the monetary rule must mainly link a restrictive monetary policy to the relative price of the non-tradable sector. On the contrary, in a nearly closed economy where the tradable sector represents a small share of national production, a fixed exchange regime becomes more suitable since it allows to keep the relative price of the tradable sector under control by avoiding frequent currency depreciation. For intermediate degree of openness, a semi-flexible exchange rate regime is more suitable.

Suggested Citation

  • Wibaut, Quentin, 1997. "Optimal exchange rate regime in a two-sector economy," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 1997032, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  • Handle: RePEc:ctl:louvir:1997032
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    File URL: http://sites.uclouvain.be/econ/DP/IRES/9732.pdf
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    References listed on IDEAS

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    1. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, January.
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    3. Fershtman, Chaim & Judd, Kenneth L & Kalai, Ehud, 1991. "Observable Contracts: Strategic Delegation and Cooperation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(3), pages 551-559, August.
    4. Katz, Michael L & Shapiro, Carl, 1986. "Technology Adoption in the Presence of Network Externalities," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 822-841, August.
    5. Bulow, Jeremy I & Geanakoplos, John D & Klemperer, Paul D, 1985. "Multimarket Oligopoly: Strategic Substitutes and Complements," Journal of Political Economy, University of Chicago Press, vol. 93(3), pages 488-511, June.
    6. Basu, Kaushik, 1995. "Stackelberg equilibrium in oligopoly: An explanation based on managerial incentives," Economics Letters, Elsevier, vol. 49(4), pages 459-464, October.
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    Cited by:

    1. Quentin Wibaut, 2001. "Centralisation de la formation des salaires en économie ouverte et politique monétaire," Reflets et perspectives de la vie économique, De Boeck Université, vol. 0(1), pages 103-115.

    More about this item

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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