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Does Exchange Rate Stability Increase Trade and Welfare ?

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Author Info
Philippe BACCHETTA
Eric VAN WINCOOP

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Abstract

We develop a simple general equilibrium framework to study the effect of the exchange rate system on trade and welfare. An important feature of the model is deviations from purchasing power parity, caused by rigid price setting in buyers' currency. We find the following. First, exchange rate stability is not necessarily associated with more trade.In a simple benchmark model with separable preferences and only monetary shocks, trade is unaffected by the exchange rate system, consistent with most evidence. Second, both trade and welfare can be higher under either exchange rate system, depending on preferences and on the monetary policy rules followed under each system. Finally, in general there is no one-to-one relationship between the levels of trade and welfare across exchange rate systems.

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Publisher Info
Paper provided by Université de Lausanne, Faculté des HEC, DEEP in its series Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) with number 9917.

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Length: 28 pages
Date of creation: Sep 1999
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Publication status: Published in American Economic Review, déc. 2000
Handle: RePEc:lau:crdeep:9917

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Postal: Université de Lausanne, Faculté des HEC, DEEP, Internef, CH-1015 Lausanne
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Web page: http://www.hec.unil.ch/deep/publications-english/e-cahiers.htm

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Related research
Keywords: exchange rate volatility; exchange rate regime;

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Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Bohn, Henning, 1990. "A positive theory of foreign currency debt," Journal of International Economics, Elsevier, vol. 29(3-4), pages 273-292, November. [Downloadable!] (restricted)
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  2. Backus, David K. & Smith, Gregor W., 1993. "Consumption and real exchange rates in dynamic economies with non-traded goods," Journal of International Economics, Elsevier, vol. 35(3-4), pages 297-316, November. [Downloadable!] (restricted)
  3. Philippe Bacchetta & Eric van Wincoop, 1998. "Does exchange rate stability increase trade and capital flows?," Research Paper 9818, Federal Reserve Bank of New York. [Downloadable!]
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  4. Baron, David P, 1976. "Flexible Exchange Rates, Forward Markets, and the Level of Trade," American Economic Review, American Economic Association, vol. 66(3), pages 253-66, June. [Downloadable!] (restricted)
  5. Betts, Caroline & Devereux, Michael B., 1996. "The exchange rate in a model of pricing-to-market," European Economic Review, Elsevier, vol. 40(3-5), pages 1007-1021, April. [Downloadable!] (restricted)
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