Choice of exchange rate regime in the presence of commodity price disturbances
This thesis discusses the choice of an exchange rate regime for a small commodity-exporting economy which experiences both monetary shocks and commodity price shocks. To investigate these matters, stochastic calculus is used in a continuous-time setting. The Franc Zone serves as an illustration: it is a currency union between a small country and a large country, and was subject to enormous strains in the last decade.\ud \ud The model developed in chapters 3 and 4 stresses the role of expectations in affecting domestic price variability, when the commodity price is described as a Poisson process. It also points to an exchange rate policy of "leaning with the wind" on the basis of the price stability criterion. Chapter 4 further investigates how the degree of openness of the small economy can influence the choice of the optimal exchange rate.\ud \ud Finally the analysis explains why the recent devaluation in the Franc Zone was a necessity in contrast to other studies which failed to notice the need for a devaluation. In this respect, it suggests a way to measure the degree of overvaluation.
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