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The Expenditure Switching Effect and the Choice Between Fixed and Floating Exchange Rates

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Senay, Ozge
Sutherland, Alan

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Abstract

A two-country sticky-price general equilibrium model is used to examine the implications of the expenditure switching effect for the welfare properties of fixed and floating exchange rate regimes. A comparison between the two regimes shows that the volatility of consumption is unambiguously lower in the floating exchange rate regime, but the volatility of home output can be higher or lower depending on the value of the elasticity of substitution between home and foreign goods. A utility-based welfare comparison of the two regimes concludes that a floating exchange rate regime yields higher welfare when the expenditure switching effect is relatively weak, but a fixed exchange rate regime is superior when the expenditure switching effect is strong.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4300.

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Date of creation: Mar 2004
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Handle: RePEc:cpr:ceprdp:4300

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Related research
Keywords: exchange rates; expenditure switching; welfare;

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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  1. Philippe Bacchetta & Eric van Wincoop, 2000. "Does Exchange-Rate Stability Increase Trade and Welfare?," American Economic Review, American Economic Association, vol. 90(5), pages 1093-1109, December. [Downloadable!] (restricted)
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  2. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  3. Lane, Philip R., 2001. "The new open economy macroeconomics: a survey," Journal of International Economics, Elsevier, vol. 54(2), pages 235-266, August. [Downloadable!] (restricted)
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  4. Maurice Obstfeld & Kenneth Rogoff, 2002. "Global Implications Of Self-Oriented National Monetary Rules," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 503-535, May. [Downloadable!] (restricted)
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  5. Giancarlo Corsetti & Paolo Pesenti, 2001. "International dimensions of optimal monetary policy," Staff Reports 124, Federal Reserve Bank of New York. [Downloadable!]
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  6. Michael B. Devereux & Charles Engel, 2000. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibility," Working Papers 042000, Hong Kong Institute for Monetary Research. [Downloadable!]
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  7. Obstfeld, M., 1998. "Risk and Exchange Rate," Papers 193, Princeton, Woodrow Wilson School - Public and International Affairs.
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  8. Devereux, Michael B, 2000. "A Simple Dynamic General Equilibrium Model Of The Tradeoff Between Fixed And Floating Exchange Rates," CEPR Discussion Papers 2403, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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