Exchange Rate Determination: A Model of the Decisive Role of Central Bank Cooperation and Conflict

The paper traces the dangers in the closed economy perspective of a   monetary policy focused on a domestic inflation goal under a clean   float.  Field evidence of the damage wrought from this perspective is   reinforced by that from a laboratory experiment.  The laboratory   experiment avoids measurement errors to which econometric estimation   is subject concerning omitted or inadequately proxied determinants,   non-normally distributed errors, inadequate degrees of freedom, false   assumptions of temporal independence and false synchronicity in   decision response lags to stimuli. Our laboratory experiment also   embeds a new theory of exchange rate determination involving the   uncontroversial power of fully cooperating central banks to totally   fix the exchange rate. The new model is within a broader theory that   includes risk effects normally excluded, SKAT, the Stages of   Knowledge Ahead Theory. We use SKAT to analyse outliers in our   experimental results, and indicate some new directions and foci for   econometric work.  Our laboratory results point to the superiority of   dollarisation, currency unions, a single world money over even dirty   floats that include the exchange rate as an objective in its own right.