TY - JOUR AU - Velasco, Andres AU - Chang, Roberto TI - Monetary Policy and the Currency Denomination of Debt: A Tale of Two Equilibria JF - National Bureau of Economic Research Working Paper Series VL - No. 10827 PY - 2004 Y2 - October 2004 DO - 10.3386/w10827 UR - http://www.nber.org/papers/w10827 L1 - http://www.nber.org/papers/w10827.pdf N1 - Author contact info: Andrés Velasco Columbia University School of International and Public Affairs 420 West 118th Street New York, NY 10027 Tel: 212/854-3899 E-Mail: avbranes@gmail.com Roberto Chang Rutgers University Department of Economics 75 Hamilton Street New Brunswick, NJ 08901 Tel: 732/932-7269 Fax: 732/932-7416 E-Mail: chang@econ.rutgers.edu AB - Exchange rate policies depend on portfolio choices, and portfolio choices depend on anticipated exchange rate policies. This opens the door to multiple equilibria in policy regimes. We construct a model in which agents optimally choose to denominate their assets and liabilities either in domestic or in foreign currency. The monetary authority optimally chooses to float or to fix the currency, after portfolios have been chosen. We identify conditions under which both fixing and floating are equilibrium policies: if agents expect fixing and arrange their portfolios accordingly, the monetary authority validates that expectation; the same happens if agents initially expect floating. We also show that a flexible exchange rate Pareto-dominates a fixed one. It follows that social welfare would rise if the monetary authority could precommit to floating. ER -