Working Paper: NBER ID: w4738
Authors: David C. Parsley; Shang-Jin Wei
Abstract: This paper casts doubt on the validity of the hysteresis hypothesis as an explanation of the persistent U.S. trade deficits in the 1980s. We propose two tests to investigate two different implications of the hypothesis. The first implication is that cumulative changes in exchange rates, in addition to current exchange rate levels, are important determinants of trade flows. The second implication is that foreign exporting firms' perceptions of exchange rate volatility will affect their decisions to enter or exit the market. We find little support for either aspect of the hysteresis hypothesis.
Keywords: Hysteresis; Trade Deficits; Exchange Rates; US Bilateral Trade
JEL Codes: F1; F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| cumulative exchange rate changes (F31) | trade flows (F10) |
| historical exchange rate changes (F31) | trade flows (F10) |
| exchange rate volatility (F31) | firms' market behavior (D21) |
| perceptions of exchange rate volatility (F31) | firms' entry and exit decisions (L11) |
| exchange rate volatility (F31) | option value of wait-and-see strategy (D84) |
| option value of wait-and-see strategy (D84) | responsiveness of trade flows (F14) |