Exchange rates, local currency pricing and international tax policies

Sihao Chen, Michael Devereux, Kang Shi () and Juanyi Xu

Journal of Monetary Economics, 2021, vol. 117, issue C, 460-472

Abstract: Empirical evidence suggests that for many countries, retail prices of traded goods are sticky in national currencies. Movements in exchange rates then cause deviations from the law of one price, and exchange rate misalignment, which cannot be corrected by monetary policy alone. This paper shows that a state contingent international tax policy can be combined with monetary policy to eliminate exchange rate misalignment and sustain a fully efficient welfare outcome. But this monetary-fiscal mix cannot be decentralized with non-cooperative determination of monetary and fiscal policy. Non-cooperative use of taxes and subsidies introduces strategic spillovers which opens up a fundamental conflict between the goals of output gap and inflation stabilization and those of terms of trade manipulation in an open economy. The implementation of an efficient monetary-fiscal mix requires effective cooperation in fiscal policy, while leaving monetary policy to be determined non-cooperatively. In addition, while an efficient outcome requires state contingent taxes and subsidies to eliminate exchange rate misalignment, it is still necessary to have flexible exchange rates and independent monetary policy.

Keywords: Local currency pricing; International tax; Exchange rate; Policy coordination (search for similar items in EconPapers)
JEL-codes: F3 F4 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Working Paper: Exchange Rates, Local Currency Pricing and International Tax Policies (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:117:y:2021:i:c:p:460-472

DOI: 10.1016/j.jmoneco.2020.02.005

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