Balance Sheets, Exchange Rate Policy, and Welfare

April 1, 2004

Preview Citation

Format: Chicago

Selim A Elekdag, and Ivan Tchakarov. Balance Sheets, Exchange Rate Policy, and Welfare, (USA: International Monetary Fund, 2004) accessed December 3, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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.

Subject: Consumption, Conventional peg, Exchange rate arrangements, Exchange rate flexibility, Foreign exchange, National accounts, Return on investment

Keywords: Consumption, Conventional peg, Debt-to-GDP threshold, East Asia, Exchange rate, Exchange rate arrangements, Exchange rate flexibility, Exchange rate movement, Exchange rate policy, Exchange rate uncertainty, Financial accelerator, Home economy, Inflation rate, Inflation targeting rule, Main exchange rate regime, Market power, Nominal exchange rate depreciation, Open economy, Optimal exchange rate regime, Price level, Return on investment, Risk premium, Second-order approximation, Transmission mechanism, Utility function, WP

Publication Details

Pages:

37
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2004/063
Stock No:

WPIEA0632004
ISBN:

9781451848458
ISSN:

1018-5941

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