Working Paper: NBER ID: w2677
Authors: Richard Baldwin; Richard Lyons
Abstract: 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.
Keywords: exchange rate volatility; trade prices; passthrough elasticity; international economics
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| exchange rate volatility (F31) | lower passthrough elasticity of trade prices (F16) |
| lower passthrough elasticity of trade prices (F16) | exchange rate volatility (F31) |
| exchange rate volatility (F31) | sluggish trade prices (F16) |
| sluggish trade prices (F16) | exchange rate volatility (F31) |
| conditional variance of exchange rates (F31) | passthrough elasticity (H30) |