Dr. David Kemme and Ph.D. student Kayhan Koleyni published in Review of International Economics

For release:  November 29, 2016

Dr. David Kemme, Morris Chair of Excellence in Economics, recently had an article published in the Review of International Economics. The paper is entitled “Exchange Rate Regimes and Welfare Losses from Foreign Crises: The Impact of the US Financial Crisis on Mexico.” Dr. Kemme co-authored the paper with Kayhan Koleyni, doctoral candidate in the department of Economics, who will graduate in December.

The choice of exchange rate regime by monetary policy makers has always been a major point of debate. While there are many options the basic choices are either to fix the exchange rate and essentially adopt the monetary policy of major trading partners, for good or bad; or to allow the exchange rate to float and adopt an independent monetary policy like domestic inflation targeting, which allows the monetary policy authority to manage inflation independent of economic conditions in the rest of the world.

Dr. Kemme and Koleyni employ a small open economy dynamic stochastic general equilibrium (DSGE) model calibrated to Mexican data to simulate the impact of the US financial crisis on Mexico, under floating and counter factual fixed exchange rates. The floating exchange rate ameliorates welfare losses for Mexico. Welfare losses are greater under fixed exchange rates because the return paths to equilibrium are more volatile (higher variance) and output, consumption, and employment impulse response functions (IRFs) overshoot. Monetary policy, inflation targeting with floating exchange rates, clearly reduced the welfare costs vis-à-vis other counter factual policies including a consumer price index-based Taylor rule, a domestic inflation Taylor rule and fixed exchange rates. The paper provides support for monetary policy makers to choose a flexible exchange rate regime with domestic inflation targeting, given the preconditions for inflation targeting are met.