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

Author: Michael B Devereux; Charles Engel
Publisher: Cambridge, Mass. National Bureau of Economic Research 2006.
Series: Working paper series (National Bureau of Economic Research), no. w12215.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
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  Read more...
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Details

Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: Michael B Devereux; Charles Engel
OCLC Number: 1027314021
Notes: May 2006.
Description: 1 online resource.
Details: Mode of access: World Wide Web.
Series Title: Working paper series (National Bureau of Economic Research), no. w12215.
Responsibility: Michael B. Devereux, Charles Engel.

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.

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