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The Expenditure Switching Effect and the Choice Between Fixed and Floating Exchange Rates

  • Senay, Ozge
  • Sutherland, Alan

A two-country sticky-price general equilibrium model is used to examine the implications of the expenditure switching effect for the welfare properties of fixed and floating exchange rate regimes. A comparison between the two regimes shows that the volatility of consumption is unambiguously lower in the floating exchange rate regime, but the volatility of home output can be higher or lower depending on the value of the elasticity of substitution between home and foreign goods. A utility-based welfare comparison of the two regimes concludes that a floating exchange rate regime yields higher welfare when the expenditure switching effect is relatively weak, but a fixed exchange rate regime is superior when the expenditure switching effect is strong.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4300.

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Date of creation: Mar 2004
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Handle: RePEc:cpr:ceprdp:4300
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  1. Michael Devereux & Charles Engel, 2000. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibiity," Discussion Papers in Economics at the University of Washington 0016, Department of Economics at the University of Washington.
  2. Eric van Wincoop & Philippe Bacchetta, 2000. "Does Exchange-Rate Stability Increase Trade and Welfare?," American Economic Review, American Economic Association, vol. 90(5), pages 1093-1109, December.
  3. Giancarlo Corsetti & Paolo Pesenti, 2001. "International Dimensions of Optimal Monetary Policy," NBER Working Papers 8230, National Bureau of Economic Research, Inc.
  4. Maurice Obstfeld and Kenneth Rogoff., 1995. "Exchange Rate Dynamics Redux," Center for International and Development Economics Research (CIDER) Working Papers C95-048, University of California at Berkeley.
  5. Maurice Obstfeld and Kenneth Rogoff., 2001. "Global Implications of Self-Oriented National Monetary Rules," Center for International and Development Economics Research (CIDER) Working Papers C01-120, University of California at Berkeley.
  6. Lane, Philip R., 2001. "The new open economy macroeconomics: a survey," Journal of International Economics, Elsevier, vol. 54(2), pages 235-266, August.
  7. Devereux, Michael B, 2000. "A Simple Dynamic General Equilibrium Model Of The Tradeoff Between Fixed And Floating Exchange Rates," CEPR Discussion Papers 2403, C.E.P.R. Discussion Papers.
  8. Maurice Obstfeld & Kenneth Rogoff, 1998. "Risk and Exchange Rates," NBER Working Papers 6694, National Bureau of Economic Research, Inc.
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