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Menu Costs, Trade Flows, and Exchange Rate Volatility

  • Lewis, Logan T.

    ()

    (Board of Governors of the Federal Reserve System (U.S.))

U.S. imports and exports respond little to exchange rate changes in the short run. Pricing behavior has long been thought central to explaining this response: if local prices do not respond to exchange rates, neither will trade flows. Sticky prices and strategic complementarities in price setting generate sluggish responses, and they are necessary to match newly available international micro price data. Using trade flow data, I test models capable of replicating these trade price data. Even with significant pricing frictions, the models still imply a trade response to exchange rates stronger than found in the data. Moreover, using significant cross-sector heterogeneity, comparative statics implied by the model find little to no support in the data. These results suggest that while complementarity in price setting and sticky prices can explain pricing patterns, some other short-run friction is needed to match actual trade flows. Furthermore, the muted response found for sectors with high long-run substitutability implies that simply assuming low elasticities may be inappropriate. Finally, there is evidence of an asymmetric response to exchange rate changes.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 1102.

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Length: 41 pages
Date of creation: 16 Apr 2014
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Handle: RePEc:fip:fedgif:1102
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  1. David Weinstein & Christian Broda, 2004. "Globalization and the Gains from Variety," Econometric Society 2004 North American Summer Meetings 508, Econometric Society.
  2. Lutz Kilian & Robert J. Vigfusson, 2011. "Are the responses of the U.S. economy asymmetric in energy price increases and decreases?," Quantitative Economics, Econometric Society, vol. 2(3), pages 419-453, November.
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  16. Doireann Fitzgerald & Stefanie Haller, 2014. "Pricing-to-Market: Evidence From Plant-Level Prices," Review of Economic Studies, Oxford University Press, vol. 81(2), pages 761-786.
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