NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Optimal Exchange Rate Policy: The Influence of Price Setting and Asset Markets

Charles Engel

NBER Working Paper No. 7889
Issued in September 2000
NBER Program(s):   IFM

This paper examines optimal exchange-rate policy in two-country sticky-price general equilibrium models in which households and firms optimize over an infinite horizon in an environment of uncertainty. The models are in the vein of the new open-economy macroeconomics' as exemplified by Obstfeld and Rogoff (1995, 1998, 2000). The conditions under which fixed or floating exchange rates yield higher welfare depend on the exact nature of price stickiness and on the degree of risk-sharing opportunities. This paper presents some preliminary empirical evidence on the behavior of consumer prices in Mexico that suggests failures of the law of one price are important. The evidence on price setting and risk-sharing opportunities is not refined enough to make definitive conclusions about the optimal exchange-rate regime for that country.

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Document Object Identifier (DOI): 10.3386/w7889

Published:

  • Journal of Money, Credit, and Banking, Vol. 33, no. 2, part 2 (May 2001): 518-541 ,
  • Charles Engel, 2001. "Optimal exchange rate policy: the influence of price setting and asset markets," Proceedings, Federal Reserve Bank of Cleveland, pages 518-547.

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