Currency mismatch, openness and exchange rate regime choice

The paper analyzes the choice of an exchange rate regime for a small open economy indebted in foreign-currency, incorporating the financial accelerator. Conventional wisdom suggests that floating regimes should insulate the economy from real shocks. I show that this result depends on the degree of openness of the economy and foreign-currency indebtedness and, in fact, does not hold for relatively closed economies. The transmission mechanism relies on non-linearities in the impact of unanticipated real price changes on the external finance premium in the spirit of Fisher (1933).