Exchange Rate Regimes for a Small Economy in a Multi-Country World

Victor Argy, Warwick McKibbin, Eric Siegloff

Research output: Book/ReportBookpeer-review

Abstract

A small country is confronted with a number of options regarding exchange-rate policy: It may tie its currency to the currency of a large country such as the U.S. dollar, Japanese yen, or German mark; it may tie its currency to a basket of currencies; or it can allow, its currency to float. Each of these options has potential benefits and costs that .depend on factors such as the shocks facing the economy, the form of wage setting within the economy, or the exchange-rate arrangements between the major countries.

The purpose of this study is to examine these issues in a theoretical framework and then to provide some empirical measure of the implications of alternative regimes for output and inflation. Chapter 2 presents a theoretical Three-country model in which one country is small relative to the two large countries. Chapter 3 uses the model to examine the consequences, of different assumptions about exchange-rate arrangements and wage setting for the transmission of various real and monetary shocks. It focuses on the impact effects of shocks with sticky prices and then on the long-run effect of shocks with full price adjustment. Chapter 4 describes the MSG2 model of the world ,economy, a dynamic general-equilibrium model, which is used to determine the magnitudes of the results identified in Chapter 3 and to describe the dynamics of adjustment between the extremes of short-run and long-run adjustment examined in the theoretical model. Chapter 5 reexamines the different assumptions about wage setting and exchange-rate arrangements in the more complicated dynamic model. The theoretical analysis gives the major insights into the implications of alternative regimes but throws up ambiguous results in many cases. The more complete empirical model gives some idea of the sizes of major differences and describes, a more complicated adjustment process than is possible in the theoretical model. Chapter 6 summarizes our conclusions.

As in most of this literature, we focus on the performance of exchangerate regimes in the face of real and monetary disturbances that may originate in the small country or in larger foreign countries. In addition, we examine the importance of wage-setting arrangements, especially as they interact with the exchange-rate regime.
Original languageEnglish
Place of PublicationPrinceton
PublisherPrinceton University Press
Number of pages56
ISBN (Print)0-88165-239-3, 9780881652390
Publication statusPublished - Dec 1989
Externally publishedYes

Publication series

NamePrinceton Studies in International Finance
PublisherPrinceton University Press
No.67
ISSN (Print)0081-8070

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