Working Paper: NBER ID: w2017
Authors: Richard Baldwin; Paul R. Krugman
Abstract: This paper presents a theoretical basis fcr the srgunent that large exchange rate shocks - such as the rise of the dollar from 1980 to 1985 - may shift historical relationships between exchange rates and trade flows. We begin with partial models in which large exchange rate fluctuations lead to entry or exit decisions that are not reversed when the currency returns to its previous level. When we develop a simple model of the feedback from "hysteresis" in trade to the exchange rate itself. Here we see that a large capital inflow, which leads to an initial appreciation, can result in a persistent reduction in the exchange rate consistent with trade balance.
Keywords: exchange rate shocks; trade effects; hysteresis
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| large exchange rate shocks (F31) | permanent entry by foreign firms (F23) |
| permanent entry by foreign firms (F23) | alteration of trade dynamics (F12) |
| large exchange rate shocks (F31) | abandonment of markets by U.S. firms (F23) |
| large exchange rate shocks (F31) | establishment of foreign firms in domestic markets (F23) |
| foreign firms' investments in marketing and distribution (F23) | persistence in market presence (L19) |
| persistence in market presence (L19) | persistent shift in trade-exchange rate relationship (F31) |
| large exchange rate shocks (F31) | structural change in trade patterns due to hysteresis (F12) |