Optimal exchange rate flexibility in an economy with intersectoral rigidities and nontraded goods

Resum

This paper develops a two-sector imperfect information stochastic model that can be used to examine the stabilizing features of fixed versus flexible exchange rates. The analysis makes several points. We show that if the monetary authority possesses superior information, a flexible exchange rate will stabilize output in both the tradeable and non-tradeable sectors. However, if the monetary authority does not possess superior information, the optimal regime will depend on the relative magnitudes of domestic versus foreign aggregate shocks, and on the importance of sector-specific variability. A fixed exchange rate rule will minimize the deviation of output from its full information level in tradeables, but will tend to increase the output gap in non-tradeables. In general, we find that the optimal regime implies neither a completely fixed nor a completely flexible exchange rate.