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Michael B. Devereux, Charles Engel
NBER Working Paper No. 6992*
Issued in March 1999
NBER Program(s): IFM
---- Abstract -----
We investigate the choice of exchange-rate regime fixed or floating in a dynamic, intertemporal general equilibrium framework. Our framework extends Devereux and Engel (1998) by investigating the implications of internationalized production. We examine the role of price-setting -- whether prices are set in the currency of producers or the currency of consumers in determining the optimality of exchange-rate regimes in an environment of uncertainty created by monetary shocks. We find that when prices are set in producers' currencies, floating exchange rates are preferred when the country is large enough, or not too risk averse. On the other hand, floating exchange rates are always preferred when prices are set in consumers' currencies because floating exchange rates allow domestic consumption to be insulated from foreign monetary shocks. The gains from floating exchange rates are greater when there is internationalized production in this case.
*Published: Topics in Empirical International Economics: Festschrift in Honor of Robert Lipsey, Blomstrom, Magnus and Linda Goldberg, eds., Chicago: University of Chicago Press and NBER.
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