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Exogenous Shocks and Exchange Rate Regimes

Authors


  • We are grateful to the anonymous referee of this journal for his/her detailed suggestions and the participants of the conference on ‘Globalization, Monetary Integration and Exchange Rate Regimes in East Asia’ (GMIEER) in November 2010 for their helpful comments on the first draft of the manuscript. Earlier version of this paper was presented at the 12th International Convention of the East Asian Economic Association in October 2010.

Abstract

Using a dynamic stochastic general equilibrium (DSGE) model with nominal price rigidity and imperfect competition, we examine the impact of terms-of-trade and foreign interest rate shocks on some key macroeconomic variables for a small open economy under different exchange rate regimes. Numerical solutions from the model are found consistent with empirical panel VAR results of 33 Asian economies for the period of 1980–2009. From both the theoretical model and empirical evidence, we find that (i) output responses to terms-of-trade and foreign interest rate shocks are smoother in floats, (ii) price responses to terms-of-trade shocks are smoother in floats than in pegs, while its responses to foreign interest shocks are more volatile in floats than in pegs, and (iii) the effects of terms-of-trade and foreign interest shocks are more prolonged under floats.

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