Expenditure Switching vs. Real Exchange Rate Stabilization: Competing Objectives for Exchange Rate Policy / Michael B. Devereux, Charles Engel.

Format:

Book

Author/Creator:

Devereux, Michael B.

Contributor:

National Bureau of Economic Research.

Engel, Charles.

Series:

Working Paper Series (National Bureau of Economic Research) no. w12215.

NBER working paper series no. w12215

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Expenditure Switching vs. Real Exchange Rate Stabilization

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2006.

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 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.

Notes:

Print version record

May 2006.