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The Devil you Know: Pegs vs Floats with Uncertain Outcomes
Author(s) -
Bizuneh Menna,
Valev Neven
Publication year - 2014
Publication title -
review of international economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.513
H-Index - 58
eISSN - 1467-9396
pISSN - 0965-7576
DOI - 10.1111/roie.12120
Subject(s) - devaluation , economics , exchange rate , inflation (cosmology) , currency , monetary economics , shock (circulatory) , exchange rate regime , currency board , point (geometry) , keynesian economics , macroeconomics , mathematics , physics , medicine , geometry , theoretical physics
Theory predicts that a fixed exchange rate regime will be abandoned after a sizable economic shock as currency devaluation could stimulate exports and output. However, devaluation is risky as the new level of the exchange rate and the rate of inflation cannot be predicted. We show that this uncertainty creates resistance to devaluation. Policymakers prefer to maintain the fixed exchange rate and to undergo internal adjustment. We illustrate the point theoretically and provide supporting evidence from B ulgaria's currency board.