Wages, Relative Prices, and the Choice between Fixed and Flexible Exchange Rates

Richard C. Marston

NBER Working Paper No. 793 (Also Reprint No. r0268)
Issued in October 1981
NBER Program(s):International Trade and Investment, International Finance and Macroeconomics

This paper reexamines the choice between fixed and flexible rates to take into account wage indexation and flexible prices. The model employed is of a small open economy faced by monetary and aggregate demand disturbances originating at ham and abroad. Aggregate supply behavior in this &el varies depending upon whether wages are set in one-period labor contracts or are indexed to current changes in the general price level, Two central conclusions emerge from the analysis. First, for all disturbances the difference in output variation between fixed and flexible rates is dependent upon the degree of wage indexation, being proportional to one minus the degree of wage indexation in the domestic economy. Thus the more highly indexed the economy, the less difference the choice of exchange rate regime makes to output variation, Secondly, the effect of foreign disturbances on the domestic economy depends as much on foreign wage and price behavior as domestic. If the rest of the world is fully indexed, flexible rates insulate the domestic country completely from foreign monetary disturbances, If the rest of the world is more highly indexed than the domestic country, then for high price elasticities at least, a flexible rate dampens the output variation associated with foreign demand disturbances.

download in pdf format
   (234 K)

download in djvu format
   (186 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w0793

Published: Marston, Richard C. "Wages, Relative Prices, and the Choice between Fixed and Flexible Exchange Rates." Canadian Journal of Economics, Vol. XV, No. 1,(February 1982), pp. 87-103.

Users who downloaded this paper also downloaded* these:
Edwards w5756 The Determinants of the Choice between Fixed and Flexible Exchange-Rate Regimes
Collins and Park Exchange Rates, Wages, and Productivity
Frankel w7338 No Single Currency Regime is Right for All Countries or At All Times
Goldberg and Tracy Exchange Rates and Local Labor Markets
Devereux and Engel w6867 Fixed vs. Floating Exchange Rates: How Price Setting Affects the Optimal Choice of Exchange-Rate Regime
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us