Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/145309
Authors: 
Groll, Dominik
Monacelli, Tommaso
Year of Publication: 
2016
Series/Report no.: 
Kiel Working Paper 2048
Abstract: 
The desirability of flexible exchange rates is a central tenet in international macroeconomics. We show that, with forward-looking staggered pricing, this result crucially depends on the monetary authority's ability to commit. Under full commitment, flexible exchange rates generally dominate a monetary union (or fixed exchange rate) regime. Under discretion, this result is overturned: a monetary union dominates flexible exchange rates. By fixing the nominal exchange rate, a benevolent monetary authority finds it welfare improving to trade off flexibility in the adjustment of the terms of trade in order to improve on its ability to manage the private sector's expectations. Thus, inertia in the terms of trade (induced by a fixed exchange rate) is a cost under commitment, whereas it is a benefit under discretion, for it acts like a commitment device.
Subjects: 
monetary union
flexible exchange rates
commitment
discretion
welfare losses
nominal rigidities
JEL: 
E52
F33
F41
Document Type: 
Working Paper

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