On the Optimal Combination of Commercial and Exchange Rate Policies

Abstract

The adoption of managed float by major countries during the seventies renewed the debate about optimal exchange rate regimes. Despite continuous research on this question, the answers are still far from reflecting a coherent, unified view. Indeed, the spectrum of such views still ranges from those that support pure float to those that view a modified gold standard as the preferred regime. A growing body of literature points out, however, that the choice among the regimes might depend on the nature of the shocks facing the country, as well as on the structure of the economy.' Most of the studies of this question did not deal with issues related to the choice of commercial policy, but concentrated instead, on comparing the performance of each regime when subject to a given commercial policy.2 Independently of this debate, contributions in the theory of commercial policies have studied the non-equivalence of quotas and tariffs as alternative means of commercial policy.3 The stimulus for this research came from Bhagwati's study on the non-equivalence of the two policies [2]. Most of the discussions of this question were conducted in a pure exchange economy, and omitted issues related to the choice of exchange rate regimes. In trade theory, there has been limited discussion of issues related to the interaction between commercial and exchange rate policies,4 and most writers have not studied the optimal coupling of exchange rate and commercial policies. The purpose of this study is to analyze these issues in the case of an economy facing