Does exchange rate stability increase trade and capital flows?

Philippe Bacchetta and Eric van Wincoop

No 9818, Research Paper from Federal Reserve Bank of New York

Abstract: On the eve of a major change in the world monetary system, the adoption of a single currency in Europe, our theoretical understanding of the implications of the exchange rate regime for trade and capital flows is still limited. We argue that two key model ingredients are essential to address this question: a general equilibrium setup and deviations from purchasing power parity. By developing a simple benchmark monetary model that contains these two ingredients, we find the following main results. First, the level of trade is not necessarily higher under a fixed exchange rate regime. Second, the level of net capital flows tends to be higher under a fixed exchange rate regime when there is a preference for domestic bonds, which is the case when the rate of relative risk-aversion is larger than one. Third, the asset market structure, including the presence of a forward market, does not qualitatively affect the results.

Keywords: Foreign exchange rates; European Monetary System (Organization); Monetary policy; Capital movements (search for similar items in EconPapers)
Date: 1998
New Economics Papers: this item is included in nep-ifn and nep-mon
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Citations: View citations in EconPapers (67)

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Related works:
Working Paper: Does Exchange Rate Stability Increase Trade and Capital Flows? (1998)
Working Paper: Does Exchange Rate Stability Increase Trade and Capital Flows? (1998)
Working Paper: Does Exchange Rate Stability Increase Trade and Capital Flows? (1998)
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