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Exchange-Rate Pass-Through and the Welfare Effects of the Euro

  • Michael Devereux
  • Charles Engel
  • Cedric Tille

This paper explores the implications of the European single currency within a simple sticky price intertemporal model. The main issue we focus on is how the euro may alter the responsiveness of consumer prices to exchange rate changes. Our central conjectures is that the acceptance of the euro will lead European prices to become more insulated from exchange-rate volatility, much the way U.S. consumer prices already are. We show that this has profound consequences for both the volatility and levels of macroeconomic aggregates in both the U.S. and Europe. We find that European welfare is enhanced, and, more surprisingly U.S. shares in Europe's good fortune. Alternative assumptions about how pricing behavior will change lead to different conclusions, but in all cases we can derive specific implications for expected levels and volatility of macroeconomic varialbes.

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Paper provided by Department of Economics at the University of Washington in its series Discussion Papers in Economics at the University of Washington with number 0034.

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Date of creation: Sep 1999
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Handle: RePEc:fth:washer:0034
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  1. Bacchetta, Philippe & van Wincoop, Eric, 1998. "Does Exchange Rate Stability Increase Trade and Capital Flows?," CEPR Discussion Papers 1962, C.E.P.R. Discussion Papers.
  2. Michael B. Devereux & Charles Engel, 1998. "Fixed vs. Floating Exchange Rates: How Price Setting Affects the Optimal Choice of Exchange-Rate Regime," NBER Working Papers 6867, National Bureau of Economic Research, Inc.
  3. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  4. Barry Eichengreen, 1991. "Is Europe an Optimum Currency Area?," NBER Working Papers 3579, National Bureau of Economic Research, Inc.
  5. Richard Portes & Helene Rey, 1998. "The Emergence of the Euro as an International Currency," NBER Working Papers 6424, National Bureau of Economic Research, Inc.
  6. Haskel, Jonathan & Wolf, Holger C, 1999. "Why Does the 'Law of One Price' Fail? A Case Study," CEPR Discussion Papers 2187, C.E.P.R. Discussion Papers.
  7. Charles Engel & John H. Rogers, 1995. "How wide is the border?," Research Working Paper 95-09, Federal Reserve Bank of Kansas City.
  8. Maurice Obstfeld & Kenneth Rogoff, 1998. "Risk and Exchange Rates," NBER Working Papers 6694, National Bureau of Economic Research, Inc.
  9. Tamim Bayoumi and Barry Eichengreen., 1992. "Shocking Aspects of European Monetary Unification," Economics Working Papers 92-187, University of California at Berkeley.
  10. Maurice Obstfeld and Kenneth Rogoff., 1999. "New Directions for Stochastic Open Economy Models," Center for International and Development Economics Research (CIDER) Working Papers C99-107, University of California at Berkeley.
  11. Giancarlo Corsetti & Paolo Pesenti, 1997. "Welfare and Macroeconomic Interdependence," NBER Working Papers 6307, National Bureau of Economic Research, Inc.
  12. Maurice Obstfeld & Giovanni Peri, 1999. "Regional Nonadjustment and Fiscal Policy: Lessons for EMU," NBER Working Papers 6431, National Bureau of Economic Research, Inc.
  13. Helpman, Elhanan, 1981. "An Exploration in the Theory of Exchange-Rate Regimes," Scholarly Articles 3445091, Harvard University Department of Economics.
  14. Giovannini, Alberto, 1988. "Exchange rates and traded goods prices," Journal of International Economics, Elsevier, vol. 24(1-2), pages 45-68, February.
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