TY  - JOUR
AU  - Devereux,Michael B.
AU  - Engel,Charles
TI  - Fixed vs. Floating Exchange Rates:  How Price Setting Affects the Optimal Choice of Exchange-Rate Regime
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 6867
PY  - 1998
Y2  - December 1998
UR  - http://www.nber.org/papers/w6867
L1  - http://www.nber.org/papers/w6867.pdf
N1  - Author contact info:
Michael B. Devereux
Department of Economics
University of British Columbia
997-1873 East Mall
Vancouver, BC V6T 1Z1
CANADA
Tel: 604/822-2542
Fax: 604/822-5915
E-Mail: mbdevereux@gmail.com

Charles Engel
Department of Economics
University of Wisconsin
1180 Observatory Drive
Madison, WI  53706-1393
Tel: 608/262-3697
Fax: 608/262-2033
E-Mail: cengel@ssc.wisc.edu
AB  - We investigate the welfare properties of fixed and floating exchange rate regimes in a two-country, dynamic, infinite-horizon model with agents optimizing in an environment of uncertainty created by monetary shocks.  The optimal exchange rate regime may depend on whether prices are set in the currency of producers or the currency of consumers. When prices are set in consumers' currency, the variance of home consumption is not influenced by foreign monetary variance under floating exchange rates, while there is transmission of foreign disturbances under floating rates if prices are set in producers' currencies, or under fixed exchange rates.  An important feature of the model is the exchange rate regime affects not just the variance of consumption and output, but also their average levels.   When prices are set in producer's currency, as in the traditional framework, we find that there is a trade-off between floating and fixed exchange rates.  Exchange rate adjustment under floating rates allows for a lower variance of consumption, but exchange rate volatility itself leads to a lower average level of consumption.  When prices are set in consumer's currency, floating exchange rates always dominate fixed exchange rates.
ER  -