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Does Exchange-Rate Stability Increase Trade and Welfare?

  • Eric van Wincoop
  • Philippe Bacchetta

This paper develops 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. In a benchmark model with separable preferences and only monetary shocks, trade is unaffected by the exchange-rate system, consistent with most evidence. In general, 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. There is no one-to-one relationship between the levels of trade and welfare across exchange-rate systems.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.90.5.1093
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 90 (2000)
Issue (Month): 5 (December)
Pages: 1093-1109

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Handle: RePEc:aea:aecrev:v:90:y:2000:i:5:p:1093-1109
Note: DOI: 10.1257/aer.90.5.1093
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  1. 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.
  2. Philippe Bacchetta & Eric van Wincoop, 1998. "Does exchange rate stability increase trade and capital flows?," Research Paper 9818, Federal Reserve Bank of New York.
  3. 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.
  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.
  5. Bohn, Henning, 1990. "A positive theory of foreign currency debt," Journal of International Economics, Elsevier, vol. 29(3-4), pages 273-292, November.
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