Has Australia's floating exchange rate regime been optimal?
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This paper develops a straightforward theoretical framework for evaluating exchange rate regime choice for small economies. It proposes that a floating exchange rate minimises national income and employment variation when real macroeconomic shocks predominate, whereas a pegged exchange rate achieves this goal should money demand shocks predominate. It then shows econometrically that, in the case of Australia, a floating exchange rate best suited the economy for the period 1985 to 2010, because real shocks were more significant than monetary shocks. Moreover, consistent with the theory, further results showing that a stronger (weaker) exchange rate correlated with positive (negative) deviations from trend GDP affirm that a floating exchange rate regime was optimal for Australia over this time.
Copyright 2012 Elsevier Inc. This is the author-manuscript version of this paper. Reproduced in accordance with the copyright policy of the publisher. Please refer to the journal's website for access to the definitive, published version.
International Economics and International Finance
Macroeconomics (incl. Monetary and Fiscal Theory)