To Peg or Not To Peg? A Simple Model of Exchange Rate Regime Choice In Small Economies

Abstract

The choice of an exchange rate peg often points to a trade-off between gaining credibility and losing flexibility. We show that the flexibility loss may be reduced if domestic and foreign shocks are coorelated and more volatile. Allowing for a plausible structural change after a peg, a flexibility gain may result.Exchange rate regime choice; credibility versus flexibility; international spill-overs; imported stabilization