Report Number

1995-002

Abstract

With common global shocks, a leader-follower fixed-exchange-rate regime improves on a non-cooperative flexible-rate regime when the spillover effects from each country;s money supply to the other country's output are symmetric. However, small exchange market shocks, from random capital flows, may undermine the incentives for either country to be the follower. Furthermore, a regime in which exchange rates are fixed when transitory exchange-market shocks are small and flexible with larger shock always dominates a flexible-rate regime, in marked contrast to (credible) target-zone models that call for pegged rates only at upper or lower bounds in response to large shocks.

Keywords

Exchange Rate, International Finance

Date of this Version

1995

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