Caroline Betts

Exchange rate dynamics in a model of pricing-to-market

Abstract This paper develops a general equilibrium exchange rate model consistent with the weak empirical evidence supporting the law of one price. Some firms segment markets by country, and set prices in local currency of sale, a practice we refer to as pricing-to-market (PTM). The presence of PTM increases exchange rate volatility, relative to a situation where the law of one price holds. PTM also affects the international transmission of monetary and fiscal policy. The higher is the degree of PTM, the lower is the comovement in consumption across countries, but the higher is the comovement in output. In terms of welfare, monetary policy is a “beggar-thy-neighbor” instrument in the presence of a high degree of PTM.

The exchange rate in a model of pricing-to-market

Abstract Much recent evidence suggests that exchange rate movements have very little effect on prices of traded goods. This paper presents some fresh evidence on this phenomenon, and develops a general equilibrium model consistent with the non-response of prices to exchange rate movements that are generated by money shocks. In the model some firms engage in pricing-to-market (PTM) across countries. The main question addressed is the degree to which PTM itself affects the behaviour of the exchange rate. It is shown that the presence of pricing-to-market combined with sticky local-currency nominal prices magnifies the response of the exchange rate to money shocks, and that the degree of exchange rate variability may be increased considerably relative to a model where the law of one price holds continuously.

Real Exchange Rate Movements and the Relative Price of Non-traded Goods

We study the quarterly bilateral real exchange rate and the relative price of non-traded to traded goods for 1225 country pairs over 1980-2005. We show that the two variables are positively correlated, but that movements in the relative price measure are smaller than those in the real exchange rate. The relation between the two variables is stronger when there is an intense trade relationship between two countries and when the variance of the real exchange rate between them is small. The relation does not change for rich/poor country bilateral pairs or for high inflation/low inflation country pairs. We identify an anomaly: The relation between the real exchange rate and relative price of non-traded goods for US/EU bilateral trade partners is unusually weak.

A Small Open Economy in Depression: Lessons from Canada in the 1930s

This paper tests the hypothesis that idiosyncratic U.S. disturbances and their international propagation can account for the global Depression. Exploiting common stochastic trends in U.S. and Canadian interwar data, we estimate a small open economy model for Canada that decomposes output fluctuations into sources identifiable with world and country-specific disturbances. We find that the onset, depth and duration of output collapse in both Canada and the U.S. are primarily attributable to a common, permanent output shock leaving little significant role for idiosyncratic disturbances originating in either economy.

Trade, Reform, and Structural Transformation in South Korea

We develop a two-country, three-sector model to quantify the effects of Korean trade policies for structural change from 1963 through 2000. The model features non-homothetic preferences, Armington trade, proportional import tariffs and export subsidies, and is calibrated to match sectoral value added data on Korean production and trade. Korea’s tariff liberalization increased imports and trade, especially agricultural imports, accelerating de-agriculturalization and intensifying industrialization. Korean subsidy liberalization lowered exports and trade, especially industrial exports, attenuating industrialization. Thus, while individually powerful agents for structural change, Korea’s tariff and subsidy reforms offset each other. Subsidy reform dominated quantitatively; lower trade, higher agricultural and lower industrial employment shares, and slower industrialization were observed than in a counterfactual economy with no post-1963 policy reform.

Money, Banking, and the Determination of Real and Nominal Exchange Rates

The authors consider a model where spatial separation, limited communication, and stochastic relocation create a role for banks and country-specific currencies. The same factors also permit a deviation from the law of one price. The authors examine how monetary policies influence real and nominal rates of exchange and real and nominal rates of interest under both fixed and flexible exchange rate regimes. They also demonstrate that both regimes are characterized by an indeterminacy of both the real and the nominal rate of exchange. Copyright 1997 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Real Exchange Rate Movements and the Relative Price of Non-Traded Goods

We show that the quarterly bilateral real exchange rate for 1275 country pairs over 1980–2015 is positively correlated with the relative price of non-traded to traded goods, but that movements in the relative price measure are smaller than those in the real exchange rate. Variance decompositions indicate that about one-third of deviations in levels of the real exchange rate, and about one quarter of yearly and four-yearly changes are accounted for by fluctuations in the relative price measure. The relation between the two variables is stronger when there is an intense trade relationship between two countries and when the variance of the real exchange rate between them is small. The relation is not systematically altered by the presence of rich country/poor country bilateral pairs or by high inflation/low inflation country pairs, is invariant over subsamples of the time period, and does not change when annual data including China is used. We identify an anomaly: The portion of real exchange rate variance accounted for by the relative price of non-traded goods for U.S./EU and NAFTA/EU bilateral trade partners is unusually small.