DP8983 Managing Currency Pegs

Author(s): Stephanie Schmitt-Grohé, Martín Uribe
Publication Date: May 2012
Keyword(s): capital controls, Currency pegs, downward nominal wage rigidity, pecuniary externality.
JEL(s): E31, E62, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8983

The combination of a fixed exchange rate and downward nominal wage rigidity creates a real rigidity. In turn, this real rigidity makes the economy prone to involuntary unemployment during external crises. This paper presents a graphical analysis of alternative policy strategies aimed at mitigating this source of inefficiency. First- and second-best monetary and fiscal solutions are analyzed. Second-best solutions are prudential, whereas first-best solutions are not.