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Expenditure-Switching Effect and the Choice of Exchange Rate Regime


  • Wei Dong


The author investigates the quantitative importance of the expenditure-switching effect by developing and estimating a structural sticky-price model nesting both producer currency pricing (PCP) and local currency pricing (LCP) settings. The author aims to provide empirical evidence of the magnitude of the benefits to be gained from exchange rate flexibility in terms of expenditure switching, and to contribute to the ongoing debate regarding the optimal exchange rate regime. In the author's model, the size of the expenditure-switching effect is determined by the degree of price stickiness, the fraction of firms employing PCP versus LCP, the distribution margin, and the elasticity of substitution between domestic and foreign tradable goods. The model is estimated for three small open economies: Australia, Canada, and the United Kingdom. The empirical results suggest that, among the three countries, the magnitude of the expenditure switching by domestic agents is relatively small for the United Kingdom, and comparatively large for Canada; the distribution margin in the United Kingdom is exceptionally high, which limits the degree of domestic expenditure switching initiated by nominal exchange rate movements. Moreover, expenditure switching by foreign distributors is comparatively small for Australia and Canada, since a larger fraction of Australian and Canadian firms adopt LCP for their export price-setting.

Suggested Citation

  • Wei Dong, 2007. "Expenditure-Switching Effect and the Choice of Exchange Rate Regime," Staff Working Papers 07-54, Bank of Canada.
  • Handle: RePEc:bca:bocawp:07-54

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    References listed on IDEAS

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    Cited by:

    1. Nelson Mark & Steven Lugauer & Clayton Sadler, 2012. "The Role of Household Saving in the Economic Rise of China," Working Papers 004, University of Notre Dame, Department of Economics, revised Jun 2012.
    2. Barnett, William A. & Eryilmaz, Unal, 2013. "Hopf bifurcation in the Clarida, Gali, and Gertler model," Economic Modelling, Elsevier, vol. 31(C), pages 401-404.
    3. Carlos Garcia & Jorge Restrepo & Scott Roger, 2009. "Hybrid Inflation Targeting Regimes," IMF Working Papers 09/234, International Monetary Fund.
    4. Wang, Jian, 2010. "Home bias, exchange rate disconnect, and optimal exchange rate policy," Journal of International Money and Finance, Elsevier, vol. 29(1), pages 55-78, February.
    5. Charles Engel, 2009. "Pass-Through, Exchange Rates, and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(s1), pages 177-185, February.

    More about this item


    Exchange rate regimes; International topics;

    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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