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Optimal and Time Consistent Exchange Rate Management in an Overlapping Generations Economy

  • Jonathan Eaton

This paper analyzes exchange rate management in a simple overlapping generations model. This framework is used to evaluate alternative policies in terms of their implications for the welfare of individuals in the economy.The analysis identifies two objectives of monetary policy,providing adesirable store of value and collecting seigniorage. When the chief concern is to provide a desirable store of value (as when the monetary authority's major constituency consists of the asset holders of the economy), a policy of fixing the exchange rate does better when shocks are primarily of domestic origin while floating becomes more desirable when foreign shocks predominate. When seigniorage concerns are paramount (as when the authority's constituency is the young generation) flexible rates do better.When seigniorage concernsare paramount and when the monetary authority cannot establish a reputation for conducting monetary policy in a way that makes the currency a desirable store of value, a national currency may not be viable in the absence of exchange controls. Such controls may be justified in this situation.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1196.

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Date of creation: Aug 1983
Date of revision:
Publication status: published as Eaton, Jonathan. "Optimal and Time Consistent Exchange-Rate Management inan Overlapping-Generations Economy." Journal of International Money and Finance, Vol. 4, No. 1, (March 1985), pp. 83-100.
Handle: RePEc:nbr:nberwo:1196
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  1. Kydland, Finn, 1977. "Equilibrium solutions in dynamic dominant-player models," Journal of Economic Theory, Elsevier, vol. 15(2), pages 307-324, August.
  2. Eaton, Jonathan & Turnovsky, Stephen J, 1984. "The Forward Exchange Market, Speculation, and Exchange Market Intervention," The Quarterly Journal of Economics, MIT Press, vol. 99(1), pages 45-69, February.
  3. Willem H. Buiter & Jonathan Eaton, 1980. "Policy Decentralization and Exchange Rate Management in Interdependent Economies," NBER Working Papers 0531, National Bureau of Economic Research, Inc.
  4. Kareken, John & Wallace, Neil, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 96(2), pages 207-22, May.
  5. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467.
  6. Aizenman, Joshua, 1981. "The use of the balance of payments as a shock absorber in fixed rate and managed float systems," Journal of International Economics, Elsevier, vol. 11(4), pages 479-486, November.
  7. Calvo, Guillermo A, 1978. "On the Time Consistency of Optimal Policy in a Monetary Economy," Econometrica, Econometric Society, vol. 46(6), pages 1411-28, November.
  8. Elhanan Helpman & Assaf Razin, 1979. "Towards a Consistent Comparison of Alternative Exchange Rate Systems," Canadian Journal of Economics, Canadian Economics Association, vol. 12(3), pages 394-409, August.
  9. Stockman, Alan C, 1980. "A Theory of Exchange Rate Determination," Journal of Political Economy, University of Chicago Press, vol. 88(4), pages 673-98, August.
  10. David A. Hsieh, 1982. "International Risk Sharing and the Choice of Exchange-Rate Regime," NBER Working Papers 0842, National Bureau of Economic Research, Inc.
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