Does Exchange Rate Stability Increase Trade and Capital Flows?

Philippe Bacchetta and Eric van Wincoop

No 1962, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: On the eve of a major change in the world monetary system, the adoption of a single currency in Europe, our theoretical understanding of the implications of the exchange rate regime for trade and capital flows is still limited. We argue that two key model ingredients are essential to address this question: a general equilibrium set-up and deviations from purchasing power parity. By developing a simple benchmark monetary model that contains these two ingredients, we find the following main results. First, the level of trade is not necessarily higher under a fixed exchange rate regime. Second, the level of net capital flows tends to be higher under a fixed exchange rate regime when there is a preference for domestic bonds, which is the case when the rate of relative risk-aversion is larger than one. Third, the asset market structure, including the presence of a forward market, does not qualitatively affect the results.

Keywords: Capital Flows; Exchange Rate Uncertainty; Trade (search for similar items in EconPapers)
JEL-codes: F31 F33 F41 (search for similar items in EconPapers)
Date: 1998-09
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Citations: View citations in EconPapers (75)

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Related works:
Working Paper: Does exchange rate stability increase trade and capital flows? (1998)
Working Paper: Does Exchange Rate Stability Increase Trade and Capital Flows? (1998)
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