Fixed Exchange Rates and Sticky Prices in Emerging Markets
Author(s)
Miles, William F. S.
Abstract
In the wake of financial crises in emerging markets, firmly fixed exchange rates and even dollarization have been advocated as a means to decrease vulnerability. There are many important new issues related to fixing the exchange rate and financial vulnerability, but one long-time vital concern for a fixed currency regime persists: the flexibility of domestic prices and wages. In the presence of high nominal rigidities, fixed rates can lead to large output costs in the aftermath of negative macroeconomic shocks. Employing a method previously applied to the gold standard fixed rate regime, we find generally flat aggregate supply curves in a sample of five emerging markets. This indicates substantial inflexibility of prices, and large losses in terms of income and employment in a fixed exchange rate regime subsequent to negative shocks.
