Essays on exchange rate regimes, external constraints on monetary policy, and financial distress

Chapter I explores the link between financial distress that feeds into the real economy and the exchange rate regime. In a model that incorporates a financial accelerator mechanism in a small open economy with money and nominal price rigidities, my principle finding is that balance sheets effects are much stronger under fixed rates than under flexible rates. This occurs even when debt is denominated in units of foreign currency. Finally, unexpectedly delaying the abandonment of the exchange rate peg after a shock can produce financial distress nearly as bad as it occurs under a permanent peg.; Chapter II evaluates the response of an economy to adverse shocks under fixed and flexible rates in a center periphery model focusing on financial distress and trade links across countries. I show that under fixed rates shocks to the economy have strong real effects. Under flexible rates, on the contrary, the central bank mitigates the effects of the shocks by adopting a counter-cyclical monetary policy that stabilizes asset prices and firms' balance sheets. To analyze the role of trade links, I consider the case where the two periphery countries have different exchange rate regimes. I find that the country on flexible rates, aside from reducing financial distress, has a competitive advantage in the center market. However, the timing of the devaluation is essential: With an initial defense of the exchange rate peg, the country sacrifices most of the beneficial effects of flexible rates.; Chapter III solves analytically for the scenario in which the duration of the fixed exchange rate regime is uncertain: I consider an “hybrid” regime in which the exchange rate is initially fixed, but then is abandoned probabilistically. Assuming that the switching probability is constant and history-independent, I first solve for the deterministic case and then assign probabilities to alternative abandonment choices of the central bank. The agents' expectations are used to compute the response of the economy to stochastic shocks under uncertain duration of the fixed exchange rate regime.