Hong Kong University of Science and Technology
Clear Water Bay
Institutional Affiliation: Hong Kong University of Science and Technology
NBER Working Papers and Publications
|September 2018||Exchange Rates, Local Currency Pricing and International Tax Policies|
with Michael B. Devereux, Jenny Xu, Kang Shi: w25111
Empirical evidence suggests that for many countries, retail prices of traded goods are sticky in national currencies. Movements in exchange rates then cause deviations from the law of one price, and exchange rate ëmisalignmentí, which cannot be corrected by monetary policy alone. This paper shows that a state contingent international tax policy can be combined with monetary policy to eliminate exchange rate misalignment and sustain a fully efficient welfare outcome. But this monetary-fiscal mix cannot be decentralized with non-cooperative determination of monetary and fiscal policy. Non-cooperative use of taxes and subsidies introduces strategic spillovers which opens up a fundamental conflict between the goals of output gap and inflation stabilization and those of terms of trade manipulat...