Fixed on Flexible: Rethinking Exchange Rate Regimes after the Great Recession

53 Pages Posted: 11 Aug 2017

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

University of Cambridge; University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)

Keith Kuester

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Gernot J. Müller

University of Tuebingen - Department of Economics

Date Written: August 2017

Abstract

The zero lower bound problem during the Great Recession has exposed the limits of monetary autonomy, prompting a reevaluation of the relative benefits of currency pegs and monetary unions (see e.g. Cook and Devereux, 2016). We revisit this issue from the perspective of a small open economy. While a peg can be beneficial when the recession originates domestically, we show that a float dominates in the face of deflationary demand shocks abroad. When the rest of the world is in a liquidity trap, the domestic currency depreciates in nominal and real terms even in the absence of domestic monetary stimulus (if domestic rates are also at the zero lower bound) -- enhancing the country's competitiveness and insulating to some extent the domestic economy from foreign deflationary pressure.

Keywords: Benign coincidence, Currency union, Exchange rate, Exchange rate peg, external shock, Fiscal Multiplier, great recession, zero lower bound

JEL Classification: E31, F41, F42

Suggested Citation

Corsetti, Giancarlo and Kuester, Keith and Müller, Gernot J., Fixed on Flexible: Rethinking Exchange Rate Regimes after the Great Recession (August 2017). CEPR Discussion Paper No. DP12197, Available at SSRN: https://ssrn.com/abstract=3016783

Giancarlo Corsetti (Contact Author)

University of Cambridge ( email )

University of Rome III - Department of Economics ( email )

via Ostiense 139
Rome, 00154
Italy
+39 06 5737 4056 (Phone)
+39 06 5737 4093 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Keith Kuester

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Gernot J. Müller

University of Tuebingen - Department of Economics ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

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