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Does Exchange Rate Stability Increase Trade and Capital Flows?

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Author Info
Philippe Bacchetta () (Studienzentrum Gerzensee, University of Lausanne, and CEPR)
Eric van Wincoop () (University of Virginia)

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Abstract

On the eve of a major change in the world monetary system, the adoption of a single currency in Europe, our theoretical understanding of the implications of the exchange rate regime for trade and capital flows is still limited. We argue that two key model ingredients are essential to address this question: a general equilibrium setup and deviations from purchasing power parity. By developing a simple benchmark monetary model that contains these two ingredients, we find the following main results. First, the level of trade is not necessarily higher under a fixed exchange rate regime. Second, the level of net capital flows tends to be higher under a fixed exchange rate regime when there is a preference for domestic bonds, which is the case when the rate of relative risk-aversion is larger than one. Third, the asset market structure, including the presence of a forward market, does not qualitatively affect the results.

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Paper provided by Swiss National Bank, Study Center Gerzensee in its series Working Papers with number 98.04.

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Length: 42 pages
Date of creation: Jul 1998
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Handle: RePEc:szg:worpap:9804

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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

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References listed on IDEAS
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