DP440 Price and Trade Effects of Exchange Rate Fluctuations and the Design of Policy Coordinaton

Author(s): Daniel Cohen, Charles Wyplosz
Publication Date: August 1990
Keyword(s): Exchange Rates, Fiscal Policy, Monetary Policy, Policy Coordination, Trade Model
JEL(s): E63, F11, F31
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=440

We analyze a two-country zone facing a joint inflationary shock and responding with coordinated and uncoordinated monetary and fiscal policies. We show that the standard presumption that the absence of coordination results in an excessive exchange rate appreciation of the zone with respect to the rest of the world hinges on a specific assumption: that within the two countries considered, the price effect of exchange rate fluctuations dominates the trade effects relatively to the corresponding effects vis-a-vis the rest of the world. If the relative hierarchy goes the other way around (as we argue is likely for EC countries), the standard conclusion is reversed, resulting in insufficiently active monetary and fiscal policies. The paper considers asymmetric shocks as well as monetary policy coordination.