The Interdependence of the Exchange Rate Policies of Two Small Competing Countries
Introduction
In this study, we analyse the interdependence of the exchange rate policies of two small countries competing with each other. The concrete cause for writing this essay is, of course, the chain of devaluations undertaken by Finland and Sweden last autumn. Our main objective is to introduce a framework by which an interdependence of this kind can be studied at an abstract level.
The discussion of the exchange rate policy rules has been one source of ideas. The main contributions to this debate have been given by Korkman, who provides a theoretical discussion of three alternative rules for exchange rate policy: the fixed exchange rate rule, the inflation norm, and the competitiveness norm. (See Korkman, 1980, pp. 79–86). In his study, Korkman discusses the usefulness of these rules in neutralizing various exogenous shocks.
We also introduce some norms analogous to those of Korkman. However, the target of the norms presented in this essay is the neutralization of one specific exogenous disturbance not analysed by Korkman: the exchange rate measures taken by the competitor of our home country. One additional remark is worth noticing. We shall not suggest that one of the norms introduced in this paper should be followed by the authorities. By the norms, we try to describe one aspect of the real decision making process.
When conducting the analysis, we use Aoki’s method for analysing dynamic interdependent systems. (See Aoki, 1981). By this method, we can study, among other things, one important but easily neglected aspect associated with the interdependence of the exchange rate policies: how do structural differences between the countries affect the nature of interdependence? This is one of the principal questions
we deal with in this paper.
We, performe all considerations by using a very simple three-country model which is set up in chapter 2. In chapter 3 we carry out policy evaluations of some exchange rate policy measures and in chapter 4 we study the problem of the interdependence of the exchange rate policies more thoroughly. Some concluding comments are presented in chapter 5.
- ISSN: 0357-9603
- ISBN: 951-9281-36-3
- Publication in PDF-format
