Optimal Exchange Rate Policy: The Influence of Price Setting and Asset Markets
National Bureau of Economic Research, 2000 - Foreign exchange administration - 53 pages
This paper examines optimal exchange-rate policy in two-country sticky-price general equilibrium models in which households and firms optimize over an infinite horizon in an environment of uncertainty. The models are in the vein of the new open-economy macroeconomics' as exemplified by Obstfeld and Rogoff (1995, 1998, 2000). The conditions under which fixed or floating exchange rates yield higher welfare depend on the exact nature of price stickiness and on the degree of risk-sharing opportunities. This paper presents some preliminary empirical evidence on the behavior of consumer prices in Mexico that suggests failures of the law of one price are important. The evidence on price setting and risk-sharing opportunities is not refined enough to make definitive conclusions about the optimal exchange-rate regime for that country
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asset trade capital flows capital mobility Caroline Hoxby Charles Engel choice of exchange-rate cē-e Cē-P condition consumer prices consumption insurance countries currency David Laibson Devereux and Engel deviations dollar price empirical evidence equilibrium exchange rate changes exchange-rate regime fixed exchange rates fixed versus floating flexible exchange rates floating exchange rates floating rates horizons households idiosyncratic risk Kenneth Rogoff local-currency pricing Mexican firms Mexican producers mixed pricing monetary policy monetary shocks monetary variance money supply monopolistic NBER Working Papers nominal contingent claims nominal exchange rate nominal prices Number Obstfeld and Rogoff open-economy macroeconomics pass-through peso price Pēn preset price for Mexican price holds price index prices are set prices in Mexico purchasing power parity rates are preferred real exchange rate relative price risk averse risk sharing short run sticky trade balance traded goods prices U.S. dollars U.S. producers variance of consumption welfare criteria www.nber.org