Dynamic Effect of Change in Exchange Rate System -From the Fixed Exchange Rate Regime to the Basket-peg or Floating Regime
We quantify dynamic effect of shifts of exchange rate system from the dollar-peg to the basket- peg or floating and obtain transition paths for the shifts, based on a dynamic small open-economy model. We find that a small open country will be better off shifting to the basket-peg or floating regime than maintaining the dollar-peg regime with capital control, in the long-run. Furthermore, because of welfare costs associated with volatility in nominal interest rates, the longer the transition period, the more benefits a country gains from shifting suddenly to the basket-peg from the dollar- peg regime rather than proceeding gradually. Thidly, focusing on sudden shifts to desired regimes, welfare gain of the country is higher under a shift to the basket-peg if the exchagne rate fluctuates remarkably. Lastly, concerning with shifting to the managed floating, it is less attractive to adopt compared with shifting to the basket-peg as intervening to maintain the exchange rate for certain periods leads to higher losses as the authority lacks monetary policy autonomy..
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