Relative Price Risk in the Open Economy -- The Case of Fixed Exchange Rates

While it is a long-standing idea in international macroeconomic theory that flexible nominal exchange rates have the potential to facilitate adjustment in international relative prices, a monetary union necessarily forgoes this mechanism for facilitating macroeconomic adjustment among its regions. Twenty years of experience in the eurozone monetary union, including the eurozone crisis, have spurred new macroeconomic research on the costs of giving up nominal exchange rates as a tool of adjustment, and the possibility of alternative policies to promote macroeconomic adjustment. Empirical evidence paints a mixed picture regarding the usefulness of nominal exchange rate flexibility: In many historical settings, flexible nominal exchanges rates tend to create more relative price distortions than they have helped resolve; yet, in some contexts exchange rate devaluations can serve as a useful correction to severe relative price misalignments. Theoretical advances in studying open economy models either support the usefulness of exchange rate movements or find them irrelevant, depending on the specific characteristics of the model economy, including the particular specification of nominal rigidities, international openness in goods markets, and international financial integration. Yet in models that embody certain key aspects of the countries suffering the brunt of the eurozone crisis, such as over-borrowing and persistently high wages, it is found that nominal devaluation can be useful to prevent the type of excessive rise in unemployment observed. This theoretical research also raises alternative polices and mechanisms to substitute for nominal exchange rate adjustment. These policies include the standard fiscal tools of optimal currency area theory but also extend to a broader set of tools including import tariffs, export subsidies, and prudential taxes on capital flows. Certain combinations of these policies, labeled a “fiscal devaluation,” have been found in theory to replicate the effects of a currency devaluation in the context of a monetary union such as the eurozone. These theoretical developments are helpful for understanding the history of experiences in the eurozone, such as the eurozone crisis. They are also helpful for thinking about options for preventing such crises in the future.

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The Stabilization of an Open Economy with Capital Controls: An Analysis Using Malaysian Data

Asian Economic Papers ◽

10.1162/asep.2003.2.3.63 ◽

2003 ◽

Vol 2 (3) ◽

pp. 63-83 ◽

Cited By ~ 3

Author(s):

Naoyuki Yoshino ◽

Sahoko Kaji ◽

Yoko Ibuka

Keyword(s):

Exchange Rate ◽

Exchange Rates ◽

Open Economy ◽

Exchange Rate Volatility ◽

Capital Controls ◽

Loss Functions ◽

Economic Welfare ◽

Real Gdp ◽

Net Exports ◽

Fixed Exchange Rates

The purpose of this paper is to analyze the effectiveness of capital controls and fixed exchange rates in improving economic welfare. We apply Malaysian data to our theoretical model and derive the following results for the period of our estimation. High exchange rate volatility negatively affects Malaysian net exports and real GDP. By stabilizing the exchange rate and recovering monetary policy autonomy, capital controls and fixed exchange rates can lead to lower values of loss functions. This beneficial effect is stronger, the more open the Malaysian economy.

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A ‘STYLIZED’ MODEL OF A HIGHLY OPEN ECONOMY UNDER A SYSTEM OF FIXED EXCHANGE RATES AND ITS IMPLICATIONS FOR THE ESTABLISHMENT OF CURRENCY AREAS1

Oxford Bulletin of Economics and Statistics ◽

10.1111/j.1468-0084.1975.mp37003003.x ◽

2009 ◽

Vol 37 (3) ◽

pp. 211-225 ◽

Cited By ~ 3

Author(s):

R. S. MASERA

Keyword(s):

Exchange Rates ◽

Open Economy ◽

Fixed Exchange Rates

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A nonlinear macrodynamic model with fixed exchange rates: Its dynamics and noise effects

Discrete Dynamics in Nature and Society ◽

10.1155/s1026022600000303 ◽

2000 ◽

Vol 4 (4) ◽

pp. 319-331 ◽

Cited By ~ 3

Author(s):

Toichiro Asada ◽

Toichio Inaba ◽

Tetsuya Misawa

Keyword(s):

Exchange Rates ◽

Open Economy ◽

Chaotic Dynamics ◽

Small Open Economy ◽

Three Dimensional ◽

Basic Structure ◽

Stochastic Disturbances ◽

Noise Effects ◽

Fixed Exchange Rates ◽

Linear Approximation Method

In this paper, we formulate a discrete time version of the Kaldorian macrodynamic model in a small open economy with fixed exchange rates. The model is described by a system of the three-dimensional nonlinear difference equations with and without stochastic disturbances (noise effects). We study the local stability/instability properties analytically by using the linear approximation method, and chaotic dynamics with and without noise effects are investigated by means of numerical simulations. In general, it is believed that the effect of the noise is to obscure the basic structure of the system. But, this is not necessarily the case. We show by means of numerical analysis that the noise can reveal the hidden structure of the model contrary to the usual intuition in some situations.

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