How Valuable is Exchange Rate Flexibilty? Optimal Monetary Policy Under Sectoral Shocks

52 Pages Posted: 31 Jul 2006

See all articles by Cédric Tille

Cédric Tille

Graduate Institute of International and Development Studies (HEI)

Date Written: March 2002

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: optimal monetary policy, exchange rate flexibility, competitiveness

JEL Classification: F31, F41, F42

Suggested Citation

Tille, Cedric, How Valuable is Exchange Rate Flexibilty? Optimal Monetary Policy Under Sectoral Shocks (March 2002). FRB of New York Staff Report No. 147. Available at SSRN: https://ssrn.com/abstract=920843 or http://dx.doi.org/10.2139/ssrn.920843

Cedric Tille (Contact Author)

Graduate Institute of International and Development Studies (HEI) ( email )

PO Box 136
Geneva, CH-1211
Switzerland

HOME PAGE: http://sites.google.com/site/cedrictilleheid/home

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