How valuable is exchange rate flexibility? Optimal monetary policy under sectoral shocks

Cédric Tille

No 147, Staff Reports from Federal Reserve Bank of New York

Abstract: The paper explores the optimal monetary policy reaction to productivity shocks in an open economy. Whereas earlier studies assume that countries specialize in producing particular goods, I enrich the analysis by allowing for incomplete specialization. I confirm the finding of Obstfeld and Rogoff (2000)--who build on Friedman (1953)--that a flexible exchange rate is highly valuable in delivering the optimal response to country- specific shocks. Its value is, however, much smaller when shocks are sector-specific, because exchange rate fluctuations then lead to misallocations between different firms within a sector. The limitation on the value of flexibility is sizable even when specialization is high.

Keywords: Production (Economic theory); Foreign exchange rates (search for similar items in EconPapers)
Date: 2002
New Economics Papers: this item is included in nep-ifn and nep-mon
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Citations: View citations in EconPapers (17)

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