THREE ESSAYS ON THE THEORY OF EXCHANGE RATE REGIMES

The first chapter develops a dual exchange rate model where the commercial rate is managed, while the financial rate floats freely to equilibrate capital markets. There is one good produced and the dynamics of the financial and the commercial rate are analyzed. It is shown that the financial exchange rate is very volatile and that it will overshoot its long run equilibrium level in response to an increase in money supply or in the rate of expansion of domestic credit. Finally, the model is extended to account for nontradables. An increase in the rate of expansion of domestic credit leads to an appreciation of the real exchange rate as opposed to the depreciation discussed by Calvo and Rodriguez for flexible exchange rates.

The second chapter develops a model for a small open economy where capital is imperfectly mobile and prices are sticky in the short run, while they can adjust slowly over time in proportion to excess demand. The country follows a policy of pegging the rate of devaluation of the exchange rate. It is shown that in response to a reduction in the rate of devaluation accompanied by a simultaneous and equal reduction in the rate of expansion of domestic credit the real exchange rate will depreciate. However, it the monetary authority can only adjust slowly the rate of expansion of domestic credit, the economy will face a real appreciation of the exchange rate.

The third chapter presents a stochastic model for a small open economy. There is one good produced and consumed. Consumption is a function of real wealth, formed by domestic and foreign money. There is perfect capital mobility and the economy is subjected to monetary and real shocks. The analysis is carried out for fixed and flexible exchange rates and the choice of exchange rate regime is based on the minimization of the variance of consumption. It is shown that under money demand shocks fixed exchange rates dominate while flexible rates are preferable in the presence of money supply and real shocks. Finally, when individuals internalize the central bank's international reserves the choice is reversed.