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Menu Costs, Trade Flows, and Exchange Rate Volatility

  • Logan Lewis

    (Federal Reserve Board)

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. I test models capable of replicating price data against trade flows. Even with significant short-run 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 Society for Economic Dynamics in its series 2013 Meeting Papers with number 313.

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Date of creation: 2013
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Handle: RePEc:red:sed013:313
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