Wages, Relative Prices, and the Choice between Fixed and Flexible Exchange Rates
This paper reexamines the choice between fixed and flexible rates to take into account wage indexation and flexible prices. The model employed is of a small open economy faced by monetary and aggregate demand disturbances originating at ham and abroad. Aggregate supply behavior in this &el varies depending upon whether wages are set in one-period labor contracts or are indexed to current changes in the general price level, Two central conclusions emerge from the analysis. First, for all disturbances the difference in output variation between fixed and flexible rates is dependent upon the degree of wage indexation, being proportional to one minus the degree of wage indexation in the domestic economy. Thus the more highly indexed the economy, the less difference the choice of exchange rate regime makes to output variation, Secondly, the effect of foreign disturbances on the domestic economy depends as much on foreign wage and price behavior as domestic. If the rest of the world is fully indexed, flexible rates insulate the domestic country completely from foreign monetary disturbances, If the rest of the world is more highly indexed than the domestic country, then for high price elasticities at least, a flexible rate dampens the output variation associated with foreign demand disturbances.
|Date of creation:||Oct 1981|
|Publication status:||published as Marston, Richard C. "Wages, Relative Prices, and the Choice between Fixed and Flexible Exchange Rates." Canadian Journal of Economics, Vol. XV, No. 1,(February 1982), pp. 87-103.|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
Web page: http://www.nber.org
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- Robert P. Flood & Nancy Peregrim Marion, 1980. "The Transmission of Disturbances under Alternative Exchange-Rate Regimeswith Optimal Indexing," NBER Working Papers 0500, National Bureau of Economic Research, Inc.
- Richard C. Marston, 1981. "Real and Monetary Disturbances in an Exchange-Rate Union," NBER Working Papers 0705, National Bureau of Economic Research, Inc.
- Eaton, Jonathan & Turnovsky, Stephen J., 1982. "Effects of monetary disturbances on exchange rates with risk averse speculation," Journal of International Money and Finance, Elsevier, vol. 1(1), pages 21-37, January.
- Brunner, Karl & Meltzer, Allan H., 1977. "Stabilization of the domestic and international economy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 5(1), pages 1-6, January.
- Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
- Jeffrey Sachs, 1980. "Wages, Flexible Exchange Rates, and Macroeconomic Policy," The Quarterly Journal of Economics, Oxford University Press, vol. 94(4), pages 731-747.
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