The effect of the exchange rate regime on unemployment and GDP.

Abstract

The issue to be examined is whether flexible exchange rates result in less variability in GDP and unemployment rates. Basically, with a fixed exchange rate governments cannot allow the exchange rate to fluctuate in response to external shocks to the economy, nor are they as able to use monetary and/or fiscal policy to respond to external shocks. Since an external shock cannot be accommodated by a nominal change in the exchange rate or through monetary policy, such shocks must be accommodated by changes in real economic activity, i.e., changes in GDP and unemployment. With a flexible exchange rate, an external shock can be accommodated by a change in the exchange rate, or through monetary and/or fiscal policy and should thus have less impact on unemployment and GDP. This hypothesis is theoretically studied and explained more widely in the thesis and is tested with the data available.