Managing Currency Pegs

Abstract

The combination of a fixed exchange rate and downward nominal wage rigidity creates a real rigidity.In turn, this real rigidity makes the economy prone to involuntary unemployment during external crises.This paper presents a graphical analysis of alternative policy strategies aimed at mitigating this source of inefficiency.First-and second-best monetary and fiscal solutions are analyzed.Second-best solutions are found to be prudential, whereas first-best solutions are not.

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