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Stabilization Policy in an Economy with Two Exchange Rate Regimes

Author

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  • Arndt Sven W.

    (Claremont McKenna College)

Abstract

This paper uses a flex-price open economy macro model to examine the effectiveness of U.S. monetary and fiscal policies when the dollar floats freely against the euro, but is fixed against the Chinese yuan. It is assumed that capital mobility is high between the U.S. and the Eurozone, but low between the U.S. and China. The model allows for short-run price flexibility and imperfect substitutability between domestic and foreign financial assets.The focus is on the implications for the efficacy of U.S. macro stabilization policies of China's fixed-rate strategy. While many countries have pegged their currencies to the dollar, China is large enough to have an impact. It is shown that its large size enables China to impede the effectiveness of U.S. macroeconomic policies. Indeed, while the U.S. is officially tagged as an independent floater, Chinese intervention is capable of interfering with dollar-euro flexibility and thereby creates outcomes that are more consistent with policy under fixed rates.

Suggested Citation

  • Arndt Sven W., 2012. "Stabilization Policy in an Economy with Two Exchange Rate Regimes," Global Economy Journal, De Gruyter, vol. 12(2), pages 1-15, June.
    • Handle: RePEc:bpj:glecon:v:12:y:2012:i:2:n:7
    DOI: 10.1515/1524-5861.1846
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    References listed on IDEAS

    as
    1. Yuqing Xing, 2011. "Processing Trade, Exchange Rates, and the People’s Republic of China’s Bilateral Trade Balances," Macroeconomics Working Papers 23266, East Asian Bureau of Economic Research.
    2. Sven W. Arndt, 2012. "Stabilization Policy in an Economy with Two Exchange Rate Regimes," Global Economy Journal (GEJ), World Scientific Publishing Co. Pte. Ltd., vol. 12(2), pages 1-15, April.
    3. Arndt, Sven W., 2011. "Adjustment in an Open Economy with Two Exchange-Rate Regimes," The Journal of Economic Asymmetries, Elsevier, vol. 8(2), pages 11-22.
    4. Jeffrey A. Frankel & Shang-Jin Wei, 2007. "Assessing China's exchange rate regime [‘Working with the IMF to strengthen exchange rate surveillance’]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 22(51), pages 576-627.
    5. Xing, Yuqing, 2012. "Processing trade, exchange rates and China's bilateral trade balances," Journal of Asian Economics, Elsevier, vol. 23(5), pages 540-547.
    6. Levy-Yeyati, Eduardo & Sturzenegger, Federico, 2005. "Classifying exchange rate regimes: Deeds vs. words," European Economic Review, Elsevier, vol. 49(6), pages 1603-1635, August.
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