Expenditure Switching vs. Real Exchange Rate Stabilization: Competing Objectives for Exchange Rate Policy

Michael B. Devereux () and Charles Engel ()

No 12215, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper develops a view of exchange rate policy as a trade-off between the desire to smooth fluctuations in real exchange rates so as to reduce distortions in consumption allocations, and the need to allow flexibility in the nominal exchange rate so as to facilitate terms of trade adjustment. We show that optimal nominal exchange rate volatility will reflect these competing objectives. The key determinants of how much the exchange rate should respond to shocks will depend on the extent and source of price stickiness, the elasticity of substitution between home and foreign goods, and the amount of home bias in production. Quantitatively, we find the optimal exchange rate volatility should be significantly less than would be inferred based solely on terms of trade considerations. Moreover, we find that the relationship between price stickiness and optimal exchange rate volatility may be non-monotonic.

JEL-codes: F3 F4 E5 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-fmk, nep-ifn, nep-mac and nep-mon
Date: 2006-05
Note: IFM
View citations in EconPapers

Downloads: (external link)
http://www.nber.org/papers/w12215.pdf (application/pdf)
Access to the full text is generally limited to series subscribers, however if the top level domain of the client browser is in a developing country or transition economy free access is provided. More information about subscriptions and free access is available at http://www.nber.org/wwphelp.html.

Related works:
Working Paper: Expenditure Switching vs. Real Exchange Rate Stabilization: Competing Objectives for Exchange Rate Policy (2005)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:nbr:nberwo:12215

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w12215
The price is Paper copy available by mail.

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc
Address: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Contact information at EDIRC.
Series data maintained by ().