Optimal exchange rate regime and firm dynamics
In this paper we study the optimal exchange rate regime in a two-country DSGE model with heterogeneous firms. We explore the welfare implications of policy intervention in the presence of demand shocks in a tractable framework that allows analytical solutions. We show that the optimal fluctuations of the exchange rate are smaller in an economy where the firm productivity distribution is more dispersed. We also explore the impact of trade policies that stabilize the number of exporter firms without any intervention on the foreign exchange markets. This alternative policy is motivated by the substitution between trade measures and exchange rate regimes observed in WTO countries after 1995.