Segmented Asset Markets and Optimal Exchange Rate Regimes
32 Pages Posted: 27 Jun 2007 Last revised: 30 Jul 2007
Date Written: June 2007
This paper revisits the issue of the optimal exchange rate regime in a flexible price environment. The key innovation is that we analyze this question in the context of environments where only a fraction of agents participate in asset market transactions (i.e., asset markets are segmented). Under this friction, alternative exchange rate regimes have different implications for real allocations in the economy. In particular -- and contrary to standard results under sticky prices -- we show that flexible exchange rates are optimal under monetary shocks and fixed exchange rates are optimal under real shocks.
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