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Exchange Rate Regimes and Welfare Losses from Foreign Crises: The Impact of the US Financial Crisis on Mexico
Author(s) -
Kemme David M.,
Koleyni Kayhan
Publication year - 2017
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.12259
Subject(s) - economics , dynamic stochastic general equilibrium , exchange rate , monetary policy , taylor rule , small open economy , welfare , overshoot (microwave communication) , financial crisis , monetary economics , floating exchange rate , inflation (cosmology) , macroeconomics , consumption (sociology) , inflation targeting , central bank , market economy , social science , physics , electrical engineering , sociology , theoretical physics , engineering
We modify the Gali and Monacelli small open economy dynamic stochastic general equilibrium (DSGE) model, calibrate to Mexican data and simulate the impact of the financial crisis on Mexico, under floating and counter factual fixed exchange rates. The floating exchange rate ameliorates welfare losses for Mexico. They are greater under fixed exchange rates because the return paths to equilibrium are more volatile (higher variance) and output, consumption and employment impulse response functions (IRFs) overshoot. Monetary policy, inflation targeting with floating exchange rates, clearly reduced the welfare costs vis‐à‐vis other counter factual policies including consumer price index‐based Taylor rule, domestic inflation Taylor rule and fixed exchange rates.