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The Optimal Choice of Exchange-Rate Regime: Price-Setting Rules and Internationalized Production

  • Michael B. Devereux
  • Charles Engel

We investigate the choice of exchange-rate regime fixed or floating in a dynamic, intertemporal general equilibrium framework. Our framework extends Devereux and Engel (1998) by investigating the implications of internationalized production. We examine the role of price-setting -- whether prices are set in the currency of producers or the currency of consumers in determining the optimality of exchange-rate regimes in an environment of uncertainty created by monetary shocks. We find that when prices are set in producers' currencies, floating exchange rates are preferred when the country is large enough, or not too risk averse. On the other hand, floating exchange rates are always preferred when prices are set in consumers' currencies because floating exchange rates allow domestic consumption to be insulated from foreign monetary shocks. The gains from floating exchange rates are greater when there is internationalized production in this case.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6992.

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Date of creation: Mar 1999
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Publication status: published as Blomstrom, Magnus and Linda Goldberg (eds.) Topics in Empirical International Economics: Festschrift in Honor of Robert Lipsey. Chicago: University of Chicago Press and NBER, 2001.
Handle: RePEc:nbr:nberwo:6992
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