Managed Exchange Rates

Martin Prachowny

The Economic Record, 1986, vol. 62, issue 4, 442-450

Abstract: Managed exchange rates have become a tool of macroeconomic stabilization policy. Much of the previous emphasis on parametrically chosen exchange rate regimes has missed the advantages of a strategy of a variable target exchange rate when the central bank tries to maintain equilibrium output in the face of various shocks to the economy. Based on a standard IS‐LM‐AS macromodel, optimal combinations of exchange rate and money supply changes are found that insulate the economy against all stipulated shocks. However, these combinations vary from one shock to another; therefore recognition signals are necessary. Continuous information on some variables allows the central bank to identify shocks if they can be guaranteed to occur individually, but not otherwise. As a second‐best strategy, ‘defensively managed exchange rates’ appear suitable. The paper also discusses some side effects and other practical difficulties of a managed exchange rate as an automatic stabilizer.

Date: 1986
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