In this study we contrast fixed and floating exchange rate regimes in a dynamic general equilibrium model. We find that the fundamental difference in the regimes is in the courses they imply for monetary policies. Because of policy coordination requirements, a tighter monetary policy needed to maintain a fixed exchange rate may necessitate a tightening in budget policy as well. We show that under some initial conditions voters or a social planner will favor one regime, but under other conditions they will favor the other. However, the choices of voters and a social planner are almost diametrically opposed.
Published in: _European Economic Review_ (Vol 42, No. 7, 1998, pp. 1221-1249) https://doi.org/10.1016/S0014-2921(97)00069-X.