TY  - JOUR
AU  - Lahiri,Amartya
AU  - Singh,Rajesh
AU  - Vegh,Carlos A.
TI  - Optimal exchange rate regimes: Turning Mundell-Fleming's dictum on its head
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12684
PY  - 2006
Y2  - November 2006
UR  - http://www.nber.org/papers/w12684
L1  - http://www.nber.org/papers/w12684.pdf
N1  - Author contact info:
Amartya Lahiri
Department of Economics
University of British Columbia
Vancouver, BC V6T 1Z1
Tel: 604-822-8606
E-Mail: alahiri@interchange.ubc.ca

Rajesh Singh
Department of Economics
Iowa State University
280D Heady Hall
Ames, IA  50011
Tel: 515/292-7631
E-Mail: rsingh@iastate.edu

Carlos A. Vegh
Department of Economics
Tydings Hall, Office 4118G
University of Maryland
College Park, MD 20742-7211
Tel: 301-405-3546
Fax: 301-405-3542
E-Mail: vegh@econ.bsos.umd.edu
AB  - A famous dictum in open economy macroeconomics -- which obtains in the Mundell-Fleming world of sticky prices and perfect capital mobility -- holds that the choice of the optimal exchange rate regime should depend on the type of shock hitting the economy. If shocks are predominantly real, a flexible exchange rate is optimal, whereas if shocks are mainly monetary, a fixed exchange rate is optimal.  There is no obvious reason, however, why this paradigm should be the most appropriate one to think about this important issue.  Arguably, asset market frictions may be as pervasive as goods market frictions (particularly in developing countries).  In this light, we show that in a model with flexible prices and asset market frictions, the Mundell-Fleming dictum is turned on its head: flexible rates are optimal in the presence of monetary shocks, whereas fixed rates are optimal in response to real shocks.  We thus conclude that the choice of an optimal exchange rate regime should depend not only on the type of shock (real versus monetary) but also on the type of friction (goods versus asset market).
ER  -