Working Paper: CEPR ID: DP4300
Authors: Ozge Senay; Alan Sutherland
Abstract: A two-country sticky-price general equilibrium model is used to examine the implications of the expenditure switching effect for the welfare properties of fixed and floating exchange rate regimes. A comparison between the two regimes shows that the volatility of consumption is unambiguously lower in the floating exchange rate regime, but the volatility of home output can be higher or lower depending on the value of the elasticity of substitution between home and foreign goods. A utility-based welfare comparison of the two regimes concludes that a floating exchange rate regime yields higher welfare when the expenditure switching effect is relatively weak, but a fixed exchange rate regime is superior when the expenditure switching effect is strong.
Keywords: exchange rates; expenditure switching; welfare
JEL Codes: E52; F41; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| floating exchange rate regime (F33) | volatility of consumption (D11) |
| fixed exchange rate regime (F33) | volatility of consumption (D11) |
| elasticity of substitution (low) (D11) | volatility of home output (floating rate regime) (F31) |
| elasticity of substitution (high) (D11) | volatility of home output (floating rate regime) (F31) |
| expenditure switching effect (weak) (H31) | welfare (floating exchange rate regime) (F33) |
| expenditure switching effect (strong) (H31) | welfare (fixed exchange rate regime) (F33) |