No Pain, All Gain? Exchange Rate Flexibility and the Expenditure-Switching Effect

31 Pages Posted: 15 Nov 2018

See all articles by Yan Carriere-Swallow

Yan Carriere-Swallow

International Monetary Fund (IMF)

Nicolás E. Magud

International Monetary Fund (IMF)

Juan F. Yépez

International Monetary Fund (IMF)

Date Written: September 2018

Abstract

Theoretical models on the relationship between prices and exchange rates predict that the magnitude of expenditure switching affects the optimal choice of exchange rate regime. Focusing on the transmission of terms-of-trade shocks to domestic real variables we document that the magnitude of the expenditure switching effect is positively associated to the degree of exchange rate flexibility. Moreover, results show that flexible exchange rates allow for significant adjustment in relative prices, which in turn lowers the burden of adjustment on demand for domestic goods and, in some cases, facilitates a faster and more durable external adjustment process. These results, which are robust to accounting for possible non-linearities due to balance sheet effects or currency mismatches, shed new light on the shock absorbing properties of flexible exchange rates.

Keywords: Exchange rate regime, expenditure switching, terms-of-trade, external adjustment, General, International Monetary Arrangements and Institutions, International Lending and Debt Problems, Open Economy Macroeconomics

JEL Classification: E30, F33, F34, F41

Suggested Citation

Carriere-Swallow, Yan and Magud, Nicolas E. and Yépez, Juan F., No Pain, All Gain? Exchange Rate Flexibility and the Expenditure-Switching Effect (September 2018). Available at SSRN: https://ssrn.com/abstract=3285216 or http://dx.doi.org/10.2139/ssrn.3285216

Yan Carriere-Swallow (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Nicolas E. Magud

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Juan F. Yépez

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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