Working Paper: NBER ID: w13154
Authors: Amartya Lahiri; Rajesh Singh; Carlos A. Vegh
Abstract: This paper revisits the issue of the optimal exchange rate regime in a flexible price environment. The key innovation is that we analyze this question in the context of environments where only a fraction of agents participate in asset market transactions (i.e., asset markets are segmented). Under this friction, alternative exchange rate regimes have different implications for real allocations in the economy. In particular -- and contrary to standard results under sticky prices -- we show that flexible exchange rates are optimal under monetary shocks and fixed exchange rates are optimal under real shocks.
Keywords: exchange rate regimes; asset market segmentation; monetary shocks; real shocks
JEL Codes: F3; F40; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary shocks (E39) | choice of exchange rate regime (F33) |
| monetary shocks (E39) | improved welfare outcomes under flexible exchange rates (F31) |
| flexible exchange rates (F31) | improved welfare outcomes for traders (D69) |
| real shocks (F31) | choice of exchange rate regime (F33) |
| real shocks (F31) | better welfare outcomes for nontraders under fixed exchange rates (F16) |
| fixed exchange rates (F31) | better welfare outcomes for nontraders (D69) |