Does Exchange-Rate Stability Increase Trade and Welfare?

TLDR

The paper develops a simple general‑equilibrium framework to study how the exchange‑rate system affects trade and welfare. The model incorporates deviations from purchasing‑power parity caused by rigid price setting in buyers’ currency. In the benchmark model trade is unaffected by the exchange‑rate system, but generally trade and welfare can be higher under either system depending on preferences and monetary‑policy rules, with no one‑to‑one relationship between trade and welfare levels. JEL codes: F31, F33, F41.

Abstract

This paper develops a simple general-equilibrium framework to study the effect of the exchange-rate system on trade and welfare. An important feature of the model is deviations from purchasing-power parity, caused by rigid price setting in buyers' currency. In a benchmark model with separable preferences and only monetary shocks, trade is unaffected by the exchange-rate system, consistent with most evidence. In general, both trade and welfare can be higher under either exchange-rate system, depending on preferences and on the monetary-policy rules followed under each system. There is no one-to-one relationship between the levels of trade and welfare across exchange-rate systems. (JEL F31, F33, F41)