The Mutual Amplification Effect of Exchange Rate Volatility and Unresponsive Trade Prices

24 Pages Posted: 16 Jul 2004 Last revised: 27 Oct 2022

See all articles by Richard E. Baldwin

Richard E. Baldwin

University of Geneva - Graduate Institute of International Studies (HEI); Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Richard K. Lyons

University of California, Berkeley; National Bureau of Economic Research (NBER)

Date Written: August 1988

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.

Suggested Citation

Baldwin, Richard E. and Lyons, Richard K., The Mutual Amplification Effect of Exchange Rate Volatility and Unresponsive Trade Prices (August 1988). NBER Working Paper No. w2677, Available at SSRN: https://ssrn.com/abstract=439597

Richard E. Baldwin (Contact Author)

University of Geneva - Graduate Institute of International Studies (HEI) ( email )

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Richard K. Lyons

University of California, Berkeley ( email )

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