Monetary policy in the open economy revisited: The case for exchange-rate flexibility restored

Margarida Duarte and Maurice Obstfeld

Journal of International Money and Finance, 2008, vol. 27, issue 6, pages 949-957

Abstract: This paper revisits the sticky-price pricing-to-market model of Devereux and Engel [Devereux, M.B., Engel, C., 2003. Monetary policy in the open economy revisited: price setting and exchange-rate flexibility. Review of Economic Studies 70(4), 765-783], in which fixed exchange rates are optimal even in the face of country-specific nonmonetary shocks. We show that this result hinges critically on the Devereux-Engel model's prediction that international consumption levels are perfectly synchronized under flexible prices. Realistic modifications of the model that produce nonsynchronous consumption movements - such as, the presence of nontraded goods - upset the fixed exchange rate prescription even in the absence of an expenditure-switching role of exchange rate changes.

Date: 2008
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Working Paper: Monetary Policy in the Open Economy Revisited: The Case for Exchange-Rate Flexibility Restored (2005)
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Persistent link: http://EconPapers.repec.org/RePEc:eee:jimfin:v:27:y:2008:i:6:p:949-957

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