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Charles Engel
NBER Working Paper No. 9016*
Issued in June 2002
NBER Program(s): IFM
---- Abstract -----
Nominal exchange rate changes can lead to 'expenditure switching' when they change relative international prices. A traditional argument for flexible nominal exchange rates posits that when prices are sticky in producers' currencies, nominal exchange rate movements can change relative prices between home and foreign goods. But if prices are fixed ex ante in consumers' currencies, nominal exchange rate flexibility cannot achieve any relative price adjustment. In that case nominal exchange rate fluctuations have the undesirable feature that they lead to deviations from the law of one price. The case for floating exchange rates is weakened if prices are sticky in this way. The empirical literature appears to support the notion that prices are sticky in consumers' currencies. Here, additional support for this conclusion is provided. We then review some new approaches in the theoretical literature that imply an important expenditure-switching role even when consumer prices are sticky in consumers' currencies. Further empirical research is needed to resolve the quantitative importance of the expenditure-switching role for nominal exchange rates.
*Published: Charles Engel, 2003.
"Expenditure Switching and Exchange-Rate Policy,"
NBER Chapters,
in: NBER Macroeconomics Annual 2002, Volume 17, pages 231-300
National Bureau of Economic Research, Inc.
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