Optimal Exchange Rate Regimes: Sunspots, Currency Crises, and Welfare

digital

Article

Magazine

RIVISTA INTERNAZIONALE DI SCIENZE SOCIALI

Fascicle

RIVISTA INTERNAZIONALE DI SCIENZE SOCIALI - 2004 - 2

Title

Optimal Exchange Rate Regimes: Sunspots, Currency Crises, and Welfare

Author

Carsten Krabbe Nielsen

Publisher

Vita e Pensiero

Format

Article |

Pdf

Online from

09-2017

Issn

0035-676X (print) | 1827-7918 (digital)

€ 6.00

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Description

In this two country OLG model there is a potential role for active governments since markets are incomplete. There are many coordinated policies (exchange rate regimes) that result in an optimal allocation if extrinsic uncertainty plays no role. However, if we take into account the possibility of sunspot equilibria, the set of optimal policies is drastically reduced. Whenever there is a possibility of influence by extrinsic uncertainty, one or both governments may seek to avoid this by intervening on the foreign exchange markets. When only one country does so, this may lead to a currency crisis, where the central bank is active and is with positive probability unsuccessful in its attempt to defend its currency. If the two countries form a monetary union, a coordinated fiscal policy is needed as a substitute for an optimal exchange rate regime.