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Exchange Rate Disconnect and Trade Elasticities

Paper Session

Friday, Jan. 5, 2018 2:30 PM - 4:30 PM

Pennsylvania Convention Center, 204-B
Hosted By: American Economic Association
  • Chair: Kenneth Rogoff, Harvard University

Exchange Rate Disconnect in General Equilibrium

Oleg Itskhoki
,
Princeton University
Dmitry Mukhin
,
Princeton University

Abstract

We propose a dynamic general equilibrium model of exchange rate determination, which simultaneously accounts for all major puzzles associated with nominal and real exchange rates. This includes the Meese-Rogoff disconnect puzzle, the PPP puzzle, the terms-of-trade puzzle, the Backus-Smith puzzle, and the UIP puzzle. The model has two main building blocks — the driving force (or the exogenous shock process) and the transmission mechanism — both crucial for the quantitative success of the model. The transmission mechanism — which relies on strategic complementarities in price setting, weak substitutability between domestic and foreign goods, and home bias in consumption — is tightly disciplined by the micro-level empirical estimates in the recent international macroeconomics literature. The driving force is an exogenous small but persistent shock to international asset demand, which we prove is the only type of shock that can generate the exchange rate disconnect properties. We then show that a model with this financial shock alone is quantitatively consistent with the moments describing the dynamic comovement between exchange rates and macro variables. Nominal rigidities improve on the margin the quantitative performance of the model, but are not necessary for exchange rate disconnect, as the driving force does not rely on the monetary shocks. We extend the analysis to multiple shocks and an explicit model of the financial sector to address the additional Mussa puzzle and Engel’s risk premium puzzle.

Global Trade and the Dollar

Emine Boz
,
International Monetary Fund
Gita Gopinath
,
Harvard University
Mikkel Palgborg-Moller
,
Harvard University

Abstract

We document the outsize role played by the U.S. dollar in driving international trade prices and flows. Our analysis is the first to examine the consequences of the dollar's prominence as an invoicing currency using a globally representative panel data set. We establish three facts: 1) The dollar exchange rate quantitatively dominates the bilateral exchange rate in price pass-through and trade elasticity regressions. 2) The cross-sectional heterogeneity in pass-through across country pairs is related to the share of imports invoiced in dollars. 3) Bilateral terms of trade are essentially uncorrelated with bilateral exchange rates. These results imply that the majority of international trade is best characterized by a dominant currency paradigm, as opposed to the traditional producer or local currency pricing paradigms. Our results have implications for expenditure switching, monetary policy spillovers, and the link between exchange rates and inflation.

Global Trade Flows: Revisiting the Exchange Rate Elasticities

Matthieu Bussiere
,
Bank of France
Guillaume Gaulier
,
Bank of France
Walter Steingress
,
Bank of Canada

Abstract

This paper contributes to the debate on exchange rate elasticities by providing a set of price and quantity elasticities for 51 advanced and emerging market economies. Specifically, we report for each of these countries the elasticity of trade prices and trade quantities on the export and on the import side, as well as the reaction of the trade balance. To this aim, the paper uses a large database of highly disaggregated bilateral trade flows, covering 5000 products and more than 160 trading partners. We present a range of estimates using standard regression techniques combined with generated repressors that aim to address key omitted variable biases, relating in particular to unobserved marginal costs and competitor prices in the importing market. We also subject our results to a battery of robustness checks that leave the main findings broadly unchanged. Overall, all countries in our sample satisfy the Marshall-Lerner conditions, suggesting that exchange rate changes can play an important role in addressing global trade imbalances.

Exchange Rates and Trade : A Disconnect?

Daniel Leigh
,
International Monetary Fund
Weicheng Lian
,
International Monetary Fund
Marcos Poplawski-Ribeiro
,
International Monetary Fund
Viktor Tsyrennikov
,
International Monetary Fund
Rachel Szymanski
,
International Monetary Fund

Abstract

We examine the stability and strength of the relationship between exchange rates and trade over time using three alternative approaches, mitigating the endogeneity of the relation. We find that both exchange rate pass-through and the price elasticity of trade volumes are largely stable over time. Economic slack and financial conditions affect the relationship, but there is limited evidence that participation in global value chains has significantly changed the exchange rate–trade relationship over time.
Discussant(s)
Kenneth Rogoff
,
Harvard University
Francis Kramarz
,
ENSAE
Emine Boz
,
International Monetary Fund
Thierry Mayer
,
Sciences Po
JEL Classifications
  • F1 - Trade
  • F3 - International Finance