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Persistent Trade Effects of Large Exchange Rate Shocks

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  • Richard Baldwin
  • Paul Krugman

Abstract

This paper presents a theoretical basis for the argument that large exchange rate shocks—such as the 1980s dollar cycle—may have persistent effects on trade flows and the equilibrium exchange rate itself. We begin with a partial-equilibrium model in which large exchange rate fluctuations lead to entry or exit decisions that are not reversed when the currency returns to its previous level. Then we develop a simple model of the feedback from hysteresis in trade to the exchange rate itself. Here we see that a large capital inflow, which leads to an initial appreciation, can result in a persistent reduction in the exchange rate consistent with trade balance.

Suggested Citation

  • Richard Baldwin & Paul Krugman, 1989. "Persistent Trade Effects of Large Exchange Rate Shocks," The Quarterly Journal of Economics, Oxford University Press, vol. 104(4), pages 635-654.
    • Handle: RePEc:oup:qjecon:v:104:y:1989:i:4:p:635-654.
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    File URL: http://hdl.handle.net/10.2307/2937860
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    1. Baldwin, Richard, 1990. "Hysteresis in Trade," Empirical Economics, Springer, vol. 15(2), pages 127-142.
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