To Fix or to Float? A New Theoretical Assessment

More than fifty years after the creation of the International Monetary Fund, the issue of appropriate exchange rate regimes for emerging economies is still controversial. Empirical studies suggest that these economies are borrowing constraint on the international financial markets. This paper highlights this constraint through a simple small open economy model of flexible prices to study the choice of the exchange regimes for emerging countries. The financial constraint acts as a real friction and alters the choice of the optimal exchange regime in the face of real and monetary shocks. The paper concludes that a fixed regime is never optimal