The Transmission of Disturbances under Alternative Exchange-Rate Regimes with Optimal Indexing

Robert P. Flood and Nancy Peregrim Marion

The Quarterly Journal of Economics, 1982, vol. 97, issue 1, 43-66

Abstract: The paper develops a general stochastic macroeconomic model that can be used to study the international transmission of disturbances under four alternative exchange-rate systems: uniform flexible exchange rates, uniform fixed exchange rates, and two versions of two-tier exchange rates. The analysis makes two general points. First, one cannot assume stability of structure when assessing the consequences of alternative exchange-rate regimes. For example, the slope of the aggregate supply curve and the rationally formed expectations in the asset markets can respond dramatically to the government's choice of exchange-rate regime. Second, exchange-rate regimes that provide full insulation from foreign disturbances may nevertheless be inferior to other regimes in terms of their ability to maximize social welfare.

Date: 1982
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