The Benefit of Exchange Rate Flexibility, Trade Openness and Extensive Margin

Kanda Naknoi ()

Purdue University Economics Working Papers from Purdue University, Department of Economics

Abstract: The literature on optimum currency areas argues that in the presence of countryspecific real shocks, the cost of fixing exchange rates is decreasing in the degree of trade openness. This study uses a stochastic dynamic general equilibrium model of endogenous specialization to assess the benefit of exchange rate flexibility. The benefit of exchange rate flexibility consists of the benefit along the extensive margin through adjustment in the composition of trade, and the benefit along the intensive margin through adjustment in the relative prices. Openness is found to influence these two benefits differently. Thus, the model predicts a non-monotonic relationship between openness and the benefit of exchange rate flexibility.

Keywords: Exchange rate regimes; Trade costs; Openness (search for similar items in EconPapers)
JEL-codes: F41 F42 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ifn and nep-opm
Date: 2008-11

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Persistent link: http://EconPapers.repec.org/RePEc:pur:prukra:1215

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