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The Responsiveness of Consumer Prices to Exchange Rates And the Implications for Exchange-Rate Policy: A Survey Of a Few Recent New Open-Economy..

  • Charles Engel

The traditional case for flexibility in nominal exchange rates assumes that there is nominal price stickiness that prevents relative prices from adjusting in response to real shocks. When prices are sticky in producers' currencies, nominal exchange rate changes can achieve the relative price change that is required between home and foreign goods. The nominal exchange rate flexibility provides the desired 'expenditure-switching' effect of relative price changes. But if prices are fixed ex ante in consumers' currencies, nominal exchange rate flexibility cannot achieve any relative price adjustment. In fact, nominal exchange rate fluctuations are undesirable because they lead to deviations from the law of one price. So, fixed exchange rates are optimal. The empirical literature appears to support the notion that prices are sticky in consumers' currencies. This paper surveys the approaches taken in the new open economy macroeconomic literature to formalize the role of optimal monetary policy. The survey explores how this literature has dealt with the empirical evidence on pass-through of exchange rate changes to consumer prices.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8725.

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Date of creation: Jan 2002
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Publication status: published as Engel, Charles, 2002. "The Responsiveness of Consumer Prices to Exchange Rates: A Synthesis of Some New Open Economy Macro Models," Manchester School, University of Manchester, vol. 70(0), pages 1-15, Supplemen.
Handle: RePEc:nbr:nberwo:8725
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  1. Robert Feenstra & Paul Bergin, 2003. "Pricing To Market, Staggered Contracts, And Real Exchange Rate Persistence," Working Papers 991, University of California, Davis, Department of Economics.
  2. Obstfeld, Maurice & Rogoff, Kenneth, 2001. "Global Implications of Self-Orientated National Monetary Rules," CEPR Discussion Papers 2856, C.E.P.R. Discussion Papers.
  3. 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.
  4. Michael B. Devereux & Charles Engel & CÈdric Tille, 2003. "Exchange Rate Pass-Through and the Welfare Effects of the Euro," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(1), pages 223-242, February.
  5. Charles Engel & John H. Rogers, 1994. "How Wide is the Border?," NBER Working Papers 4829, National Bureau of Economic Research, Inc.
  6. Charles Engel, 1992. "Real Exchange Rates and Relative Prices: An Empirical Investigation," NBER Working Papers 4231, National Bureau of Economic Research, Inc.
  7. Giancarlo Corsetti & Paolo Pesenti, 2001. "International dimensions of optimal monetary policy," Staff Reports 124, Federal Reserve Bank of New York.
  8. Charles Engel, 1995. "Accounting for U.S. Real Exchange Rate Changes," NBER Working Papers 5394, National Bureau of Economic Research, Inc.
  9. Maurice Obstfeld & Kenneth Rogoff, 1999. "New Directions for Stochastic Open Economy Models," NBER Working Papers 7313, National Bureau of Economic Research, Inc.
  10. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," International Trade 0012003, EconWPA.
  11. Rogers, John H. & Jenkins, Michael, 1995. "Haircuts or hysteresis? Sources of movements in real exchange rates," Journal of International Economics, Elsevier, vol. 38(3-4), pages 339-360, May.
  12. Sutherland, Alan, 2005. "Incomplete pass-through and the welfare effects of exchange rate variability," Journal of International Economics, Elsevier, vol. 65(2), pages 375-399, March.
  13. Parsley, David & Wei, Shang-Jin, 2001. "Limiting Currency Volatility to Stimulate Goods Market Integration: a Price-Based Approach," CEPR Discussion Papers 2958, C.E.P.R. Discussion Papers.
  14. Lane, Philip R., 2001. "The new open economy macroeconomics: a survey," Journal of International Economics, Elsevier, vol. 54(2), pages 235-266, August.
  15. Charles Engel, 1999. "Local-Currency Pricing and the Choice of Exchange-Rate Regime," Working Papers 0036, University of Washington, Department of Economics.
  16. Obstfeld, Maurice & Taylor, Alan M., 1997. "Nonlinear Aspects of Goods-Market Arbitrage and Adjustment: Heckscher's Commodity Points Revisited," Journal of the Japanese and International Economies, Elsevier, vol. 11(4), pages 441-479, December.
  17. Mussa, Michael, 1986. "Nominal exchange rate regimes and the behavior of real exchange rates: Evidence and implications," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 117-214, January.
  18. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-60, June.
  19. Cedric Tille, 2000. ""Beggar-thy-neighbor" or "beggar-thyself"? the income effect of exchange rate fluctuations," Staff Reports 112, Federal Reserve Bank of New York.
  20. Maurice Obstfeld., 2001. "International Macroeconomics: Beyond the Mundell-Fleming Model," Center for International and Development Economics Research (CIDER) Working Papers C01-121, University of California at Berkeley.
  21. Giancarlo Corsetti & Luca Dedola, 2002. "Macroeconomics of international price discrimination," Temi di discussione (Economic working papers) 461, Bank of Italy, Economic Research and International Relations Area.
  22. Willem H. Buiter, 1999. "The EMU and the NAMU: What is the Case for North American Monetary Union?," Canadian Public Policy, University of Toronto Press, vol. 25(3), pages 285-305, September.
  23. Charles Engel & John H. Rogers, 1999. "Deviations from Purchasing Power Parity:Causes and Welfare Costs," Discussion Papers in Economics at the University of Washington 0038, Department of Economics at the University of Washington.
  24. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," NBER Working Papers 7869, National Bureau of Economic Research, Inc.
  25. Betts, Caroline & Devereux, Michael B., 2000. "Exchange rate dynamics in a model of pricing-to-market," Journal of International Economics, Elsevier, vol. 50(1), pages 215-244, February.
  26. Maurice Obstfeld & Kenneth Rogoff, 1998. "Risk and Exchange Rates," NBER Working Papers 6694, National Bureau of Economic Research, Inc.
  27. McCallum, Bennett T. & Nelson, Edward, 1999. "Nominal income targeting in an open-economy optimizing model," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 553-578, June.
  28. Philippe BACCHETTA & Eric VAN WINCOOP, 1999. "Does Exchange Rate Stability Increase Trade and Welfare ?," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 9917, Université de Lausanne, Faculté des HEC, DEEP.
  29. Parsley, David C. & Wei, Shang-Jin, 2001. "Explaining the border effect: the role of exchange rate variability, shipping costs, and geography," Journal of International Economics, Elsevier, vol. 55(1), pages 87-105, October.
  30. Betts, Caroline & Devereux, Michael B., 1996. "The exchange rate in a model of pricing-to-market," European Economic Review, Elsevier, vol. 40(3-5), pages 1007-1021, April.
  31. Jeffrey A. Frankel, 1993. "On Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061546, June.
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