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Competitive devaluations: a welfare-based approach

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  • Giancarol Corsetti
  • Paolo Pesenti
  • Nouriel Roubini
  • Cedric Tille

Abstract

This paper studies the mechanism of international transmission of exchange rate shocks within a three-country Center-Periphery model, providing a choice-theoretic framework for the policy analysis and empirical assessment of competitive devaluations. If relative prices and terms of trade exhibit some flexibility conforming to the law of one price, a devaluation by one country is beggar-thy-neighbor relative to another country through its effects on cost-competitiveness in a third market. Yet, due to direct bilateral trade between the two countries, there is a large range of parameter values for which a country is better off by maintaining a peg in response to its partner’s devaluation. If instead deviations from the law of one price are to be considered the dominant empirical paradigm, then the beggar-thy-neighbor effect based on competition in a third market may disappear. However, a country’s devaluation has a negative welfare impact on the economies of its trading partners based on the deterioration of their export revenues and profits and the increase in disutility from higher labor effort for any level of consumption.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 58.

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Date of creation: 1999
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Handle: RePEc:fip:fednsr:58

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Keywords: Foreign exchange rates;

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  1. Allan Drazen, 1999. "Political Contagion in Currency Crises," NBER Working Papers 7211, National Bureau of Economic Research, Inc.
  2. Buiter, Willem H & Corsetti, Giancarlo & Pesenti, Paolo, 1996. "Interpreting the ERM Crisis: Country-Specific and Systemic Issues," CEPR Discussion Papers 1466, C.E.P.R. Discussion Papers.
  3. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers.
  4. John Fernald & Hali Edison & Prakash Loungani, 1998. "Was China the first domino? assessing links between China and the rest of emerging Asia," International Finance Discussion Papers 604, Board of Governors of the Federal Reserve System (U.S.).
  5. Taimur Baig & Ilan Goldfajn, 1998. "Financial Market Contagion in the Asian Crisis," IMF Working Papers 98/155, International Monetary Fund.
  6. Kaminsky, Graciela L. & Reinhart, Carmen M., 2000. "On crises, contagion, and confusion," Journal of International Economics, Elsevier, vol. 51(1), pages 145-168, June.
  7. Michael B. Devereux & Charles Engel, 1998. "Fixed vs. Floating Exchange Rates: How Price Setting Affects the Optimal Choice of Exchange-Rate Regime," NBER Working Papers 6867, National Bureau of Economic Research, Inc.
  8. Giancarlo Corsetti & Paolo Pesenti, 2001. "Welfare And Macroeconomic Interdependence," The Quarterly Journal of Economics, MIT Press, vol. 116(2), pages 421-445, May.
  9. Barry Eichengreen & Charles Wyplosz, 1993. "The Unstable EMS," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(1), pages 51-144.
  10. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
  11. Barry Eichengreen & Andrew K. Rose & Charles Wyplosz, 1996. "Contagious Currency Crises," NBER Working Papers 5681, National Bureau of Economic Research, Inc.
  12. Guillermo A. Calvo & Enrique G. Mendoza, 1999. "Regional Contagion and the Globalization of Securities Markets," NBER Working Papers 7153, National Bureau of Economic Research, Inc.
  13. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "Paper tigers? A model of the Asian crisis," Research Paper 9822, Federal Reserve Bank of New York.
  14. Obstfeld, M., 1998. "Risk and Exchange Rate," Papers 193, Princeton, Woodrow Wilson School - Public and International Affairs.
  15. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel, 1999. "What caused the Asian currency and financial crisis?," Japan and the World Economy, Elsevier, vol. 11(3), pages 305-373, October.
  16. Paul R. Masson, 1998. "Contagion," IMF Working Papers 98/142, International Monetary Fund.
  17. Kenen, Peter B., 1985. "Macroeconomic theory and policy: How the closed economy was opened," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 13, pages 625-677 Elsevier.
  18. Cedric Tille, 1999. "The role of consumption substitutability in the international transmission of shocks," Staff Reports 67, Federal Reserve Bank of New York.
  19. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  20. Li-Gang Liu & Marcus Noland & Sherman Robinson & Zhi Wang, 1998. "Asian Competitive Devaluations," Working Paper Series wp98-2, Peterson Institute for International Economics.
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