Working Paper: NBER ID: w3066
Authors: Gabriel De Kock; Vittorio Grilli
Abstract: In this paper we demonstrate that exchange rate regime switching is compatible with optimal government policies. Nominal exchange-rate regimes are formalized as equilibrium commitments on future seigniorage policies, and the collapse of an exchange-rate peg as an excusable default which allows the government to lump-sum tax private sector money holdings. We demonstrate that a regime in which the exchange-rate peg is allowed to collapse when government spending is unusually high is a trigger-strategy equilibrium. Such a regime can be superior to both fixed and flexible exchange rate because it combines some of the flexibility of the floating exchange rates with some of the benefits of precommitment afforded by fixed rates.
Keywords: exchange rate regimes; government policy; seigniorage; optimal policies
JEL Codes: F31; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| High government spending (H59) | Collapse of exchange rate peg (F31) |
| High government spending (H59) | Exchange rate regime switching (F31) |
| Collapse of exchange rate peg (F31) | Lumpsum tax on money balances (E49) |
| Collapse of exchange rate peg (F31) | Exchange rate stability (F31) |