Abstract
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.
Highlights
We have witnessed many shifts in exchange rate regimes in emerging market economies over the last 3 decades
Though both static and conventional dynamic analyses were quite appropriate in the aftermath of the 1997/98 Asian financial crisis, the scope to which monetary authorities can apply these analyses has become more limited over time
Existing static and conventional dynamic analyses are appropriate for comparing the status quo exchange rate regime with a more desirable one
Summary
We have witnessed many shifts in exchange rate regimes in emerging market economies over the last 3 decades. Static analysis focusing on the 1997/98 Asian financial crisis relies on losses over a short time horizon (e.g., 1 quarter) It compares optimality among a dollar peg, a basket peg, and a floating regime, given free capital mobility. Exchange rate regimes are assumed to remain stable over the specified horizon and are compared with one another to determine the most desirable regime over the long run.3 Though both static and conventional dynamic analyses were quite appropriate in the aftermath of the 1997/98 Asian financial crisis, the scope to which monetary authorities can apply these analyses has become more limited over time.
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