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Exogenous Shocks and Exchange Rate Management in Developing Countries

Author

Listed:
  • Sajid Anwar

    (LUMS)

  • S. Zahid Ali

Abstract

Even though globalization benefits less developed countries (LDCs), it also makes them more vulnerable to the exogenous shocks to the economies. Many LDCs rely on imported technologies and intermediate inputs to compete in the international export markets with better quality and cost efficient products. In this regard, exchange rate policies in respective countries have a direct bearing on the cost of production. This paper examines alternative exchange rate regimes to suggest an appropriate exchange rate policy in the context of developing countries. The paper utilizes a small open economy model involving direct supply-side effects of exchange rate and expectations of key economic variables and considers four possible exchange rate policies, e.g., fixed exchange rate, perfectly flexible exchange rate, leaning against the wind, and leaning with the wind. Contrary to the conventional wisdom, the paper finds that in the event of a shock, leaning against the wind is likely to be the most appropriate exchange rate policy. Moreover, in the event of rigid wages, a fixed exchange rate policy is advisable.

Suggested Citation

  • Sajid Anwar & S. Zahid Ali, 2007. "Exogenous Shocks and Exchange Rate Management in Developing Countries," Finance Working Papers 22245, East Asian Bureau of Economic Research.
  • Handle: RePEc:eab:financ:22245
    as

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    File URL: http://www.eaber.org/node/22245
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    References listed on IDEAS

    as
    1. Bailliu, Jeannine & Lafrance, Robert & Perrault, Jean-Francois, 2003. "Does Exchange Rate Policy Matter for Growth?," International Finance, Wiley Blackwell, vol. 6(3), pages 381-414, Winter.
    2. McCallum, Bennett T & Nelson, Edward, 2000. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," Oxford Review of Economic Policy, Oxford University Press, vol. 16(4), pages 74-91, Winter.
    3. Carlin Wendy & Soskice David, 2005. "The 3-Equation New Keynesian Model --- A Graphical Exposition," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-38, December.
    4. Ivan Roberts & Rod Tyers, 2003. "China's Exchange Rate Policy: The Case for Greater Flexibility," Asian Economic Journal, East Asian Economic Association, vol. 17(2), pages 155-184, June.
    5. Stanley Fischer, 1984. "Contracts, Credibility, and Disinflation," NBER Working Papers 1339, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    globalization; exchange rate regimes; exchange rate policy;

    JEL classification:

    • O24 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Trade Policy; Factor Movement; Foreign Exchange Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F30 - International Economics - - International Finance - - - General

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