The exchange rate policy of the euro: A matter of size?

This paper analyzes how country size affects exchange rate policy and Volat ility. A hump shaped relation between exchange rate variability and the siz e of countries is generated in the theoretical model: exchange rate variabi lity increases with country size for small countries but then decreases for large countries. The paper finds that this theoretical prediction holds we ll for bilateral exchange rates of the OECD countries in the period between 1980 and 1995 as web as for a subsample of European exchange rates with re spect to the dollar. The results suggest that the dollar/euro volability ma y be lower than the present dollar/DM volatility. (C) 1998 Academic Press.