NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

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

Richard Baldwin, Richard K. Lyons

NBER Working Paper No. 2677
Issued in August 1988
NBER Program(s):   ITI   IFM

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.

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Document Object Identifier (DOI): 10.3386/w2677

Published: "The Mutual Amplification Effect of Unresponsive Trade Prices and Exchange Rate Volatility." Journal of International Financial Markets, Institutions & Money, Vol. 1, No. 2, pp. 1-20, Spring 1991

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