TY  - JOUR
AU  - Aizenman,Joshua
AU  - Hausmann,Ricardo
TI  - Exchange Rate Regimes and Financial-Market Imperfections
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 7738
PY  - 2000
Y2  - June 2000
UR  - http://www.nber.org/papers/w7738
L1  - http://www.nber.org/papers/w7738.pdf
N1  - Author contact info:
Joshua Aizenman
Department of Economics;  E2
1156 High St.
University of California, Santa Cruz
Santa Cruz, CA  95064
Tel: 831/459-4791
Fax: 831/459-5077
E-Mail: jaizen@ucsc.edu

Ricardo Hausman
Harvard Kennedy School
79 JFK St.
Cambridge
MA
02138
Tel: 617-496-3740
E-Mail: ricardo_hausmann@harvard.edu
AB  - This paper investigates the design of an exchange rate policy for an economy where the domestic capital market is segmented from the global financial market, producers rely on credit to finance working capital needs, and the labor market is characterized by nominal contracts. We show that the choice of an exchange rate regime is intertwined with the financial structure -- greater reliance on working capital to finance input needs, and greater segmentation of the domestic capital market increase the desirable exchange rate stability. This result follows from the observation that greater exchange rate stability is likely to reduce the real interest rate facing the producer, thereby increasing output. Hence, greater reliance on working capital increases the welfare gain attached to the lower interest rate associated with lower flexibility of the exchange rate, thereby increasing the desirability of a fixed exchange rate. Similarly, greater integration with the global capital market reduces the real interest rate benefits from exchange rate stability, increasing thereby the optimal flexibility of the exchange rate, and reducing the demand for international reserves.
ER  -