Living with the Fear of Floating: An Optimal Policy Perspective
As documented in recent studies, developing countries (classified by the IMF as floaters or managed floaters) are extremely reluctant to allow for large nominal exchange rate fluctuations. This 'fear of floating' is reflected in the fact that, in spite of being subject to larger shocks, developing countries exhibit lower exchange rate variability and higher reserve variability than developed countries. Moreover, there is a positive correlation between changes in the exchange rate and interest rates and a negative correlation between both changes in reserves and the exchange rate and changes in interest rates and reserves. We build a simple model that rationalizes these key features as the outcome of an optimal policy response to monetary shocks. The model incorporates three key frictions: an output cost of nominal exchange rate fluctuations, an output cost of higher interest rates to defend the currency, and a fixed cost of intervention.
|Date of creation:||Jul 2001|
|Date of revision:|
|Publication status:||published as Living with the Fear of Floating: An Optimal Policy Perspective , Amartya Lahiri, Carlos A. Végh. in Preventing Currency Crises in Emerging Markets , Edwards and Frankel. 2002|
|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
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Reinhart, Carmen & Calvo, Guillermo, 2002.
"Fear of floating,"
14000, University Library of Munich, Germany.
- Sebastian Edwards & Carlos A. Vegh, 1997.
"Banks and Macroeconomics Disturbances under Predetermined Exchange Rates,"
NBER Working Papers
5977, National Bureau of Economic Research, Inc.
- Edwards, Sebastian & Vegh, Carlos A., 1997. "Banks and macroeconomic disturbances under predetermined exchange rates," Journal of Monetary Economics, Elsevier, vol. 40(2), pages 239-278, October.
- Sebastian Edwards & Carlos A. Végh, 1997. "Banks and Macroeconomic Disturbances Under Predetermined Exchange Rates," CEMA Working Papers: Serie Documentos de Trabajo. 115, Universidad del CEMA.
- Burnside, Craig & Eichenbaum, Martin & Rebelo, Sérgio, 1999.
"Hedging and Financial Fragility in Fixed Exchange Rate Regimes,"
CEPR Discussion Papers
2171, C.E.P.R. Discussion Papers.
- Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 2001. "Hedging and financial fragility in fixed exchange rate regimes," European Economic Review, Elsevier, vol. 45(7), pages 1151-1193.
- Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 1999. "Hedging and Financial Fragility in Fixed Exchange Rate Regimes," NBER Working Papers 7143, National Bureau of Economic Research, Inc.
- Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 1999. "Hedging and financial fragility in fixed exchange rate regimes," Working Paper Series WP-99-11, Federal Reserve Bank of Chicago.
- Correia, Isabel & Neves, Joao C. & Rebelo, Sergio, 1995.
"Business cycles in a small open economy,"
European Economic Review,
Elsevier, vol. 39(6), pages 1089-1113, June.
- Correia, Isabel & Neves, Joao C & Rebelo, Sérgio, 1994. "Business Cycles in a Small Open Economy," CEPR Discussion Papers 996, C.E.P.R. Discussion Papers.
- Correia, I. & Rabelo, S. & Naves, J.C., 1994. "Business Cycles in a Small Open Economy," RCER Working Papers 382, University of Rochester - Center for Economic Research (RCER).
- Carlos A. Rodríguez, 1993. "Macroeconomic Developments in Romania," CEMA Working Papers: Serie Documentos de Trabajo. 90, Universidad del CEMA.
- Agenor, Pierre-Richard & Aizenman, Joshua, 1999. "Financial sector inefficiencies and coordination failures : implications for crisis management," Policy Research Working Paper Series 2185, The World Bank.
- Eduardo Moron & Juan F. Castro, 2002. "Uncovering Central Bank Monetary Policy Objectives: Going Beyond Fear of Floating," Macroeconomics 0205002, EconWPA.
- Reinhart, Carmen & Calvo, Guillermo, 2001.
"Fixing for your life,"
13873, University Library of Munich, Germany.
- Pablo Druck & Pietro Garibaldi, 2000. "Inflation Risk and Portfolio Allocation in the Banking System," CEMA Working Papers: Serie Documentos de Trabajo. 181, Universidad del CEMA.
- Cadenillas, Abel & Zapatero, Fernando, 1999. "Optimal Central Bank Intervention in the Foreign Exchange Market," Journal of Economic Theory, Elsevier, vol. 87(1), pages 218-242, July.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:8391. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.