Aspects of the optimal management of exchange rates

This paper shows that the choice of the optimal exchange-rate regime depends on the stochastic shocks affecting the economy. The higher the variance of real shocks, the larger the desirability of fixity of exchange rates. The desirability of exchange-rate flexibility increases the larger are the variances of the shocks to the demand for money, to the supply of money, to foreign prices, and to purchasing power parities. When the economy produces traded and non-traded goods the desirability of exchange-rate flexibility diminishes the higher is the relative share of non-traded goods and the lower are the elasticities of demand and supply of the two goods.