Balance Sheets, Exchange Rate Policy, and Welfare
International Monetary Fund, Apr 1, 2004 - Business & Economics - 37 pages
The debate about the appropriate choice of exchange rate regime is fundamental in international economics. This paper develops a small open-economy model with balance sheet effects and compares the performance of fixed and flexible exchange rate regimes. The model is solved up to a second-order approximation which allows us to address the issue of risk and welfare rigorously. The paper identifies threshold levels of the debt-to-GDP ratio above which fixed exchange rate regimes are welfare superior to monetary policy rules that imply flexible exchange rate regimes. The results suggest that emerging market economies that suffer from a relatively high level of indebtedness and are constrained in their pursuit of optimal monetary policy, could find it beneficial to opt for a fixed exchange rate regime.
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Balance Sheets, Exchange Rate Policy, and Welfare, Issue 2004
Selim Elekdag,Ivan Tchakarov
Limited preview - 2004
16 percent 24 Risk Premium 31 percent accurate welfare adjustment cost augmented Taylor rule balance sheet effects behavior central bank Cespedes Chang and Velasco collateral constraints consumption and labor debt-to-GDP ratio depreciation Devereux and Lane Domestic Interest Rate DYNARE elasticity of substitution emerging market economies entrepreneur exchange rate regimes external shocks Figure ﬁnancial accelerator channel Financial Accelerator Present ﬁnancial frictions ﬁnd ﬁrst ﬁrst-order approximation ﬁxed and ﬂexible ﬁxed exchange rate ﬂexible exchange rate ﬂoat Float Peg Float foreign currency denominated Gertler household implies impulse response insulate the economy interest rate rule International Monetary Fund intratemporal elasticity level of indebtedness monetary authorities monetary policy monopolistically competitive Mundell-Fleming model Natalucci 2003 Negative Export Shock nominal exchange rate output peg dominates Peg Float Peg Percentage of Steady proﬁts second-order approximation small open economy speciﬁcation Standard Deviations Steady State Consumption sticky prices technology shock unpublished welfare analysis Welfare Comparison Welfare Loss welfare metric