The Mutual Amplification Effect of Exchange Rate Volatility and Unresponsive Trade Prices
Richard E. Baldwin
University of Geneva - Graduate Institute of International Studies (HEI); Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
Richard K. Lyons
University of California, Berkeley; National Bureau of Economic Research (NBER)
NBER Working Paper No. w2677
The volatility of flexible exchange rates greatly exceeds what most analysts anticipated at the advent of generalized floating. The Dornbusch overshooting model accounts for the fact that exchange rates fluctuate more than the underlying fundamentals. This paper presents a model which may help account for why exchange rates have been even more volatile than the overshooting model would suggest, and why trade prices have been so unresponsive in recent years. The paper employs an extended version of the sticky-price monetary model of exchange rates and a simple industrial organization model of import pricing. The combined macro-JO. model shows that exchange rate volatility and unresponsive trade prices can be mutually amplifying.
Number of Pages in PDF File: 24working papers series
Date posted: July 16, 2004
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