The global implications of regional exchange rate regimes

We examine the implications of a regional, fixed exchange rate regime for global exchange rate volatility. The concept of the optimum currency area turns out to play an important role. The formation of a regional regime tends to decrease global volatility when countries are symmetric. The effects tend to be ambiguous in the case of asymmetries. The reduction in global volatility is larger when the rest of the world has more rigid labor markets than the peggers. And when the exchange rate management is done mostly by countries with relatively more flexible labor markets. And in the presence of a negative correlation in productivity shocks across countries.