Abstract

http://ssrn.com/abstract=891015
 
 

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Expenditure Switching vs. Real Exchange Rate Stabilization: Competing Objectives for Exchange Rate Policy


Michael B. Devereux


University of British Columbia (UBC) - Department of Economics; Centre for Economic Policy Research (CEPR)

Charles M. Engel


University of Wisconsin - Madison - Department of Economics; National Bureau of Economic Research (NBER); University of Washington - Department of Economics

April 2006

ECB Working Paper No. 614

Abstract:     
This paper develops a view of exchange rate policy as a trade-off between the desire to smooth fluctuations in real exchange rates so as to reduce distortions in consumption allocations, and the need to allow flexibility in the nominal exchange rate so as to facilitate terms of trade adjustment. We show that optimal nominal exchange rate volatility will reflect these competing objectives. The key determinants of how much the exchange rate should respond to shocks will depend on the extent and source of price stickiness, as well as the elasticity of substitution between home and foreign goods. Quantitatively, we find the optimal exchange rate volatility should be significantly less than would be inferred based solely on terms of trade considerations. Moreover, we find that the relationship between price stickiness and optimal exchange rate volatility may be non-monotonic.

Number of Pages in PDF File: 49

Keywords: Exchange rates, monetary policy, expenditure switching

JEL Classification: F41, E52

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Date posted: May 22, 2006  

Suggested Citation

Devereux, Michael B. and Engel, Charles M., Expenditure Switching vs. Real Exchange Rate Stabilization: Competing Objectives for Exchange Rate Policy (April 2006). ECB Working Paper No. 614. Available at SSRN: http://ssrn.com/abstract=891015

Contact Information

Michael B. Devereux (Contact Author)
University of British Columbia (UBC) - Department of Economics ( email )
997-1873 East Mall
Vancouver, BC V6T 1Z1
Canada
604-822-2542 (Phone)
604-946-6271 (Fax)
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Charles M. Engel
University of Wisconsin - Madison - Department of Economics ( email )
1180 Observatory Drive
Madison, WI 53706
United States
608-262-3697 (Phone)
608-262-2033 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
University of Washington - Department of Economics ( email )
Box 353330
Seattle, WA 98195-3330
United States
206-543-6197 (Phone)
206-685-7477 (Fax)
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