The optimal exchange rate regime for a small country

Hiroya Akiba, Yukihiro Iida, Yoshihiro Kitamura

Research output: Contribution to journalArticle

2 Citations (Scopus)

Abstract

This paper examines the welfare comparisons between a freely floating, a managed floating, and a pegged exchange rate regime. We compare the expected loss under these regimes by modifying and generalizing Hamada's (2002) model to accommodate intervention policy. We consider the de jure and de facto classifications, where the former is defined by the officially stated intentions of the monetary authorities, while the latter is based on the actually observed behavior of the nominal exchange rate. We first examine the exchange rate regimes from the central bank's policy stance and the actual exchange rate policy. Next we assume that the regime which the private sector perceives according to an official announcement may be different from the one adopted actually by the central bank. We examine nine combinations of the de jure and de facto regimes. We interpret that, whenever they are different, there is informational friction between the central bank and the private sector. We show that the welfare level of a small country under freely floating is no less than that under other regimes, and that with some restrictive conditions, the de facto pegged or de facto managed floating is close to freely floating. This partly explains 'Fear of floating' and 'Fear of pegging'.

Original languageEnglish
Pages (from-to)315-343
Number of pages29
JournalInternational Economics and Economic Policy
Volume6
Issue number3
DOIs
Publication statusPublished - 2009 Jun 24
Externally publishedYes

Keywords

  • De jure and de facto
  • Intervention
  • Managed floating

ASJC Scopus subject areas

  • Economics and Econometrics

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