Managing Currency Pegs
The combination of a fixed exchange rate and downward nominal wage rigidity creates a real rigidity. In turn, this real rigidity makes the economy prone to involuntary unemployment during external crises. This paper presents a graphical analysis of alternative policy strategies aimed at mitigating this source of inefficiency. First- and second-best monetary and fiscal solutions are analyzed. Second-best solutions are found to be prudential, whereas first-best solutions are not.
The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.