Working Paper: NBER ID: w1196
Authors: Jonathan Eaton
Abstract: This paper analyzes exchange rate management in a simple overlapping generations model. This framework is used to evaluate alternative policies in terms of their implications for the welfare of individuals in the economy.The analysis identifies two objectives of monetary policy,providing adesirable store of value and collecting seigniorage. When the chief concern is to provide a desirable store of value (as when the monetary authority's major constituency consists of the asset holders of the economy), a policy of fixing the exchange rate does better when shocks are primarily of domestic origin while floating becomes more desirable when foreign shocks predominate. When seigniorage concerns are paramount (as when the authority's constituency is the young generation) flexible rates do better.When seigniorage concernsare paramount and when the monetary authority cannot establish a reputation for conducting monetary policy in a way that makes the currency a desirable store of value, a national currency may not be viable in the absence of exchange controls. Such controls may be justified in this situation.
Keywords: Exchange Rate Management; Overlapping Generations; Monetary Policy; Seigniorage
JEL Codes: E31; E42; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Domestic Shocks (D19) | Fixed Exchange Rate Policy (F31) |
| Fixed Exchange Rate Policy (F31) | Higher Welfare (I39) |
| Foreign Shocks (F31) | Floating Exchange Rate Policy (F31) |
| Floating Exchange Rate Policy (F31) | Higher Welfare (I39) |
| Seigniorage Concern (E49) | Flexible Exchange Rate Policy (F31) |
| Flexible Exchange Rate Policy (F31) | Higher Expected Utility (D11) |
| Lack of Credibility (D83) | Non-viability of National Currency (F31) |