Exchange Rate Bands and Optimal Monetary Accommodation Under a Dirty Float

Roel Beetsma and Frederick (Rick) van der Ploeg

No 725, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper studies regimes of managed exchange rates for a small open economy with an integrated capital market, rational expectations in financial markets, sluggish nominal wages and prices, and supply shocks that follow a Brownian motion. Each regime can be characterized by the degree to which price shocks are accommodated and the width of the exchange rate band. Special cases of monetary accommodation are a peg, a clean float and a PPP exchange rate rule. First, the optimal degree of monetary accommodation of price shocks is analysed when there is no exchange rate band. Given that the welfare loss is a weighted sum of the asymptotic variances of output and of consumer prices, monetary accommodation is particularly strong when the authorities care relatively more about full employment than price stability. More flexible labour markets induce right-wing governments to move towards a cleaner float and left-wing governments towards a PPP exchange rate rule. Second, the effects of exchange rate bands and the accompanying inframarginal interventions are examined when allowance is made for intramarginal interventions as well. Such a framework can, in contrast to the pioneering Krugman analysis, explain the observed hump-shaped unconditional density functions of EMS exchange rates.

Keywords: Brownian Motion; Dirty Floating; Exchange Rate Regimes; PPP Exchange Rate Rules; Stochastic Simulation; Supply Shocks (search for similar items in EconPapers)
JEL-codes: E0 F3 F4 (search for similar items in EconPapers)
Date: 1992-10
References: Add references at CitEc
Citations: View citations in EconPapers (8)

Downloads: (external link)
http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=725 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Working Paper: Exchange rate bands and optimal monetary accomodation under a dirty float (1992)
Working Paper: Exchange rate bands and optimal monetary accomodation under a dirty float (1992)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:725

Ordering information: This working paper can be ordered from
http://www.cepr.org/ ... pers/dp.php?dpno=725

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().