Experimental Evidence on the Benefits of Eliminating Exchange Rate Uncertainties and Why Expected Utility Theory causes Economists to Miss Them
Conclusions favourable to flexible exchange rates typically accord with expected utility theory in ignoring the costs that exchange rate uncertainty generates for governments, central banks, firms and unions in: (i) choosing among available acts; and (ii) existing until learning the outcome of the chosen act. Allowing for these costs involves the stages of knowledge ahead framework, Pope (1983, 1995, 2005). A laboratory experiment suggests that (i) and (ii) together outweigh the advantages of having a flexible exchange rate as an additional instrument for managing a country’s employment, interest rate, price level and international competitiveness goals
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