Welfare Analyzes of Exchange Rate Regimes

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This research theoretically analyzes which exchange rate regime is optimal as an exchange rate regime after the exchange rate crises in 1990's from the welfare standpoint of a small open economy. The fact that crises erupted from countries that adopted an intermediate exchange rate regime between a floating rate regime and a fixed rate regime, it has been argued that the bi-polar system would prevail among those countries. We constructed our theoretical model to compare the differences in welfare levels, keeping the difficulty in mind of selecting the optimal exchange rate regime,. because many of the crisis-hit countries have been-subject to the so-called Fear of Floating as well as Fear of Pegging . The model clearly distinguishes a de jure regime and a de facto regime. We made welfare comparisons of those regimes together with the combinations of them.In order to consider and compare a floating regime with other regimes, we inevitably construct a 3-county model. For our Welfare anal … More ysis, the loss function assumed for a small country is similar to that of the large country. In the model the central bank or the government is assumed to minimize the losses arising from unemployment and inflation. The balance of payments disequilibrium is another scam of losses for a country if they adopt a fixed or an intermediate rate regime The welfare comparison is made for a fixed rate, a floating rate, and an intermediate rate regime. We deliberately modeled an intermediate rate regime by incorporating plausible intervention activities by the central bankSeveral interesting conclusions emerge from our theoretical analysis : (a) a floating rate regime is superior to an intermediate regime in a welfare sense, (b) for a de facto intermediate regime, a de jure intermediate regime may dominate a floating regime in welfare, (c) for a de jure and de facto intermediate and a fixed regime, an intermediate regime dominates, (d) for a de jure and de facto floating and a fixed regime, a floating regime dominates, (e) for a de jure floating regime, a de facto floating dominates a de facto intermediate regime, (f) for a de facto and de jure fixed regime, and a de jure floating but de facto intermediate regime, the latter dominates in a welfare sense. Some other interesting results are also derived. Less