Optimal exchange rate regime in a two-sector economy

Quentin Wibaut ()

No 1997032, LIDAM Discussion Papers IRES from Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES)

Abstract: The present article deals with the issue of optimal degree of exchange rate flexibility. It departs from the current literature on the subject as it does not introduce nominal rigidities nor address the question of international monetary cooperation. Instead, the argument hinges on the economic structure of the economy. The existence of sectorial strategic interactions yields a welfare improving opportunity of coordination for monetary policy. Monetary policy can act as a weak-coordinating device by reducing the market power of the price setting agent. This is possible by linking the non-cooperative agents' decision to money supply (through a monetary rule). The smaller a sector, the larger its ability to set a high relative price without having to bear the bad consequences of it. As a result, the monetary rule must be more restrictive vis-à-vis small sectors. In a very open economy, that is, when the non-tradable sector is small, the monetary rule must mainly link a restrictive monetary policy to the relative price of the non-tradable sector. On the contrary, in a nearly closed economy where the tradable sector represents a small share of national production, a fixed exchange regime becomes more suitable since it allows to keep the relative price of the tradable sector under control by avoiding frequent currency depreciation. For intermediate degree of openness, a semi-flexible exchange rate regime is more suitable.

JEL-codes: E0 E5 (search for similar items in EconPapers)
Pages: 18
Date: 1997-01-01
New Economics Papers: this item is included in nep-cba and nep-ifn
References: Add references at CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://sites.uclouvain.be/econ/DP/IRES/9732.pdf (application/pdf)

Related works:
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:ctl:louvir:1997032

Access Statistics for this paper

More papers in LIDAM Discussion Papers IRES from Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) Place Montesquieu 3, 1348 Louvain-la-Neuve (Belgium). Contact information at EDIRC.
Bibliographic data for series maintained by Virginie LEBLANC ().