Working Paper: NBER ID: w0473
Authors: Rudiger Dornbusch
Abstract: This paper discusses exchange rate rules in their role as macroeconomic instruments. Two quite different approaches are pursued. The traditional view is that exchange rate flexibility is a substitute for money wage flexibility so that managed money and managed exchange rates yield the necessary instruments for internal and external balance. An entirely different perspective is offered by the modern macro-economics of wage contracting and the long run trade-off between the stability of output and the stability of inflation. In this context it is shown that exchange rate policies that seek to maintain real exchange rates or competitiveness do stabilize output but do so at the cost of in-creased inflation instability. Exchange rate rules such as full purchasing power parity crawling pegs are the analogue of full monetary accommodation of price disturbances.
Keywords: exchange rate rules; macroeconomic stability; inflation; output stability
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| exchange rate policies aimed at maintaining real exchange rates (F31) | stabilize output (E63) |
| exchange rate policies aimed at maintaining real exchange rates (F31) | increase inflation instability (E31) |
| active money and exchange rate policy (F31) | optimal policy-making (D78) |
| accommodating exchange rate policies (F33) | enhance the persistence of inflationary shocks (E31) |
| accommodating exchange rate policies (F33) | stabilize output (E63) |
| active exchange rate policy (F31) | improve employment and trade balance (E69) |
| active exchange rate policy (F31) | protracted deviations from full employment and price stability (E39) |