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On the Benefits of Exchange Rate Flexibility under Endogenous Tradedness of Goods

  • Kanda Naknoi
  • Michael Kumhof

    ()

    (Modeling Division, Research Department International Monetary Fund)

  • Douglas Laxton

Previous efforts to compare the costs and benefits of fixed versus flexible exchange rate regimes have ignored the fact that it takes significant resources and time to develop export markets, and they have not included an analysis of the firm-level decision to enter or exit export markets. This paper develops a dynamic stochastic general equilibrium model to analyze the effects of endogenous tradedness of goods on the welfare gains from exchange rate flexibility. The actual range of traded goods in our model depends on the producers who choose to enter and exit export markets taking into account trade costs and relative productivities. A novel feature of the model is that it takes both time and resources to develop export markets and as a consequence expenditure-switching effects can be slow and will depend on a host of factors such as country size, trading costs and the competitive environment that producers face. Interestingly, because the model integrates a model of trade into a monetary business cycle model with sticky prices and wages, it is possible to study the interaction of macro and structural policies. However, in this study we focus initially on how different levels of trading costs can affect the structure of the economy and result in welfare costs of excessive exchange rate volatility

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 405.

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Date of creation: 11 Nov 2005
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Handle: RePEc:sce:scecf5:405
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  1. Frankel, Jeffrey A & Rose, Andrew K, 1998. "The Endogeneity of the Optimum Currency Area Criteria," Economic Journal, Royal Economic Society, vol. 108(449), pages 1009-25, July.
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  9. Christopher J. Erceg & Luca Guerrieri & Christopher Gust, 2006. "SIGMA: a new open economy model for policy analysis," International Finance Discussion Papers 835, Board of Governors of the Federal Reserve System (U.S.).
  10. Andrew K. Rose, 1999. "One Money, One Market: Estimating the Effect of Common Currencies on Trade," NBER Working Papers 7432, National Bureau of Economic Research, Inc.
  11. Kanda Naknoi, 2005. "Real Exchange Rate Fluctuations and Endogenous Tradability," 2005 Meeting Papers 857, Society for Economic Dynamics.
  12. Roberts, M. & Tybout, J., 1993. "An Empirical Model of Sunk Costs and the Decision to Export," Papers 4-93-3, Pennsylvania State - Department of Economics.
  13. Mark J. Melitz, 2002. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," NBER Working Papers 8881, National Bureau of Economic Research, Inc.
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  17. repec:rus:hseeco:122439 is not listed on IDEAS
  18. Papa M'B. P. N'Diaye & Douglas Laxton, 2002. "Monetary Policy Credibility and the Unemployment-Inflation Tradeoff; Some Evidence From 17 Industrial Countries," IMF Working Papers 02/220, International Monetary Fund.
  19. Aitken, Brian & Hanson, Gordon H. & Harrison, Ann E., 1997. "Spillovers, foreign investment, and export behavior," Journal of International Economics, Elsevier, vol. 43(1-2), pages 103-132, August.
  20. Huang, Kevin X. D. & Liu, Zheng, 2004. "Production interdependence and welfare," Working Paper Series 0355, European Central Bank.
  21. Laxton, Douglas & Pesenti, Paolo, 2003. "Monetary rules for small, open, emerging economies," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1109-1146, July.
  22. Fagan, Gabriel & Henry, Jérôme & Mestre, Ricardo, 2001. "An area-wide model (AWM) for the euro area," Working Paper Series 0042, European Central Bank.
  23. Stephen Murchison & Andrew Rennison & Zhenhua Zhu, 2004. "A Structural Small Open-Economy Model for Canada," Working Papers 04-4, Bank of Canada.
  24. Hamid Faruqee, 2004. "Measuring the Trade Effects of EMU," IMF Working Papers 04/154, International Monetary Fund.
  25. Paul R. Bergin & Reuven Glick, 2005. "Endogenous nontradability and macroeconomic implications," Working Paper Series 2003-09, Federal Reserve Bank of San Francisco.
  26. Casares, Miguel, 2002. "Time-to-build approach in a sticky price, sticky wage optimizing monetary model," Working Paper Series 0147, European Central Bank.
  27. Juillard, Michel & Karam, Philippe & Laxton, Douglas & Pesenti, Paolo, 2006. "Welfare-based monetary policy rules in an estimated DSGE model of the US economy," Working Paper Series 0613, European Central Bank.
  28. Paul Bergin & Reuven Glick, 2005. "Endogenous Tradability andMacroeconomic Implications," Working Papers 513, University of California, Davis, Department of Economics.
  29. Smets, Frank & Wouters, Raf, 2002. "An estimated stochastic dynamic general equilibrium model of the euro area," Working Paper Series 0171, European Central Bank.
  30. Leslie Lipschitz & Alex Mourmouras & Timothy D. Lane, 2002. "Capital Flows to Transition Economies; Master or Servant," IMF Working Papers 02/11, International Monetary Fund.
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