The macroeconomic effects of monetary and fiscal policy in a small open economy: Does the exchange rate regime matter?

We propose a new dynamic transition analysis on the basis of a small open economy dynamic stochastic general equilibrium model. Our proposed analysis differs from existing static and conventional dynamic analyses in that shifts from a fixed exchange rate regime to a basket peg or a floating regime are explicitly explored. We apply quantitative analysis, using data from the People's Republic of China and Thailand, and find that both economies would be better off shifting from a dollar peg to a basket peg or a floating regime over the long run. Furthermore, the longer the transition period, the greater the benefits of shifting to a basket peg regime from a dollar peg regime owing to limited volatility in interest rates. Regarding sudden shifts to a desired regime, the welfare gains are larger under a shift to a basket peg if the exchange rate fluctuates significantly.

Download Full-text

Mobile Capital, Domestic Institutions, and Electorally Induced Monetary and Fiscal Policy

American Political Science Review ◽

10.2307/2586015 ◽

2000 ◽

Vol 94 (2) ◽

pp. 323-346 ◽

Cited By ~ 101

Author(s):

William Roberts Clark ◽

Mark Hallerberg

Keyword(s):

Exchange Rate ◽

Fiscal Policy ◽

Central Bank ◽

Open Economy ◽

Capital Mobility ◽

Formal Model ◽

Central Bank Independence ◽

Mobile Capital ◽

The Exchange Rate ◽

Monetary And Fiscal Policy

The literature on global integration and national policy autonomy often ignores a central result from open economy macroeconomics: Capital mobility constrains monetary policy when the exchange rate is fixed and fiscal policy when the exchange rate is flexible. Similarly, examinations of the electoral determinants of monetary and fiscal policy typically ignore international pressures altogether. We develop a formal model to analyze the interaction between fiscal and monetary policymakers under various exchange rate regimes and the degrees of central bank independence. We test the model using data from OECD countries. We find evidence that preelectoral monetary expansions occur only when the exchange rate is flexible and central bank independence is low; preelectoral fiscal expansions occur when the exchange rate is fixed. We then explore the implications of our model for arguments that emphasize the partisan sources of macroeconomic policy and for the conduct of fiscal policy after economic and monetary union in Europe.

Download Full-text

The long-run stability of a small, open economy under crawling peg regime

Acta Oeconomica ◽

10.1556/aoecon.52.2002.1.3 ◽

2002 ◽

Vol 52 (1) ◽

pp. 57-78

Author(s):

S. Çiftçioğlu

Keyword(s):

Exchange Rate ◽

Open Economy ◽

Risk Premium ◽

Small Open Economy ◽

Exchange Rate Policy ◽

Price Stability ◽

Output Stability ◽

Long Run ◽

The Exchange Rate ◽

The Impact

The paper analyses the long-run (steady-state) output and price stability of a small, open economy which adopts a “crawling-peg” type of exchange-rate regime in the presence of various kinds of random shocks. Analytical and simulation results suggest that with the exception of money demand shocks, an exchange rate policy which involves a relatively higher rate of indexation of the exchange rate to price level is likely to lead to the worsening of price stability for all types of shocks. On the other hand, the impact of adopting such a policy on output stability depends on the type of the shock; for policy shocks to the exchange rate and shocks to output demand, output stability is worsened whereas for the shocks to risk premium of domestic assets, supply price of domestic output and the wage rate, better output stability is achieved in the long run.

Download Full-text

A Theory of Foreign Exchange Interventions

The Review of Economic Studies ◽

10.1093/restud/rdab013 ◽

2021 ◽

Author(s):

Sebastián Fanelli ◽

Ludwig Straub

Keyword(s):

Exchange Rate ◽

Central Bank ◽

Interest Rates ◽

Open Economy ◽

Small Open Economy ◽

Bond Markets ◽

Pecuniary Externality ◽

Optimal Intervention ◽

The Exchange Rate ◽

Intervention Policy

Abstract We study a real small open economy with two key ingredients (1) partial segmentation of home and foreign bond markets and (2) a pecuniary externality that makes the real exchange rate excessively volatile in response to capital flows. Partial segmentation implies that, by intervening in the bond markets, the central bank can affect the exchange rate and the spread between home- and foreign-bond yields. Such interventions allow the central bank to address the pecuniary externality, but they are also costly, as foreigners make carry trade profits. We analytically characterize the optimal intervention policy that solves this trade-off: (1) the optimal policy leans against the wind, stabilizing the exchange rate; (2) it involves smooth spreads but allows exchange rates to jump; (3) it partly relies on “forward guidance,” with non-zero interventions even after the shock has subsided; (4) it requires credibility, in that central banks do not intervene without commitment. Finally, we shed light on the global consequences of widespread interventions, using a multi-country extension of our model. We find that, left to themselves, countries over-accumulate reserves, reducing welfare and leading to inefficiently low world interest rates.

Download Full-text