حرکت رو به جلو از طریق نرخ ارز، نوسانات نرخ ارز، و قطع کردن نرخ ارز

This paper explores the hypothesis that high volatility of real and nominal exchange rates may be due to the fact that local currency pricing eliminates the pass-through from changes in exchange rates to consumer prices. Exchange rates may be highly volatile because in a sense they have little effect on macroeconomic variables. The paper shows the ingredients necessary to construct such an explanation for exchange rate volatility. In addition to the presence of local currency pricing, we need (a) incomplete international financial markets, (b) a structure of international pricing and product distribution such that wealth effects of exchange rate changes are minimized, and (c) stochastic deviations from uncovered interest rate parity. Together, it is shown that these elements can produce exchange rate volatility that is much higher than shocks to economic fundamentals, and ‘disconnected’ from the rest of the economy in the sense that the volatility of all other macroeconomic aggregates are of the same order as that of fundamentals.

Empirical evidence indicates that nominal exchange rate changes are not fully passed through to goods prices. In fact, it appears that consumer prices are very unresponsive to nominal exchange rate changes.1 An implication of this finding is that the “expenditure-switching” effect of exchange rate changes might be very small. That is, a change in the nominal exchange rate might not lead to much substitution between domestically produced goods and internationally produced goods, because the relative prices of those goods do not change much for final users. If the exchange rate change has little effect on the behavior of final purchasers of goods, then it may take large changes in exchange rates to achieve equilibrium after some shock to fundamentals. For example, if there is a shock that reduces the supply of foreign goods, a very large home depreciation might be required in order to raise the relative price of foreign goods enough to reduce demand sufficiently. That is, low pass-through of exchange rates might imply high exchange rate volatility in equilibrium. That intuition was first expressed by Krugman (1989), and explored by Betts and Devereux (1996). However, fully articulated equilibrium open-economy macroeconomic models with sticky nominal prices (in the style of Obstfeld and Rogoff (1995)) have found that exchange rate volatility is difficult to generate even when there is little exchange rate pass-through. While Obstfeld and Rogoff (1995) assume complete pass-through of exchange rates to prices because they assume that nominal prices are set in the currency of the producer, several studies have extended the Obstfeld–Rogoff framework to the local-currency pricing case.2 Under local-currency pricing, firms set a price in their own currency for sale to households located in their country, but set a price in foreign currency for sales to foreign households. The purpose of this paper is to explore the conditions under which local-currency pricing might induce a high level of exchange rate volatility. By impeding the linkage of goods prices across countries, local currency pricing leads to deviations from purchasing power parity (PPP), and therefore, in principal, may be able to explain high exchange rate volatility following the intuition of Krugman. But there are some major caveats to this conclusion. Much of the paper is devoted to understanding them. First, if international financial markets allow for full risk-sharing across countries, then exchange rates will be determined by a risk sharing condition, despite the fact that local currency prices are independent of exchange rates. Second, even if risk sharing is limited, the linkage of assets prices through bond markets will impose a tight limit on the degree to which exchange rates can move. Third, even without any international asset trade at all, local currency pricing does not guarantee high exchange rate volatility because wealth effects of exchange rate changes through firms’ profits will limit the degree to which the exchange rate can change. Finally, while within a particular model of local currency pricing it may be feasible to choose a parameter configuration that delivers a high level of exchange rate variability (e.g. Chari et al., 2000), this parameterization may have quite counterfactual implications for other macroeconomic variables. Our aim is not just to explain high exchange rate volatility, but, in the spirit of the original Krugman discussion, to understand both why exchange rate variability can both be high and not matter for real variables. In this respect, we are influenced by the seminal empirical findings of Baxter and Stockman (1989), Flood and Rose (1995). They show that high exchange rate volatility under floating exchange rates is not obviously tied to or reflected in high volatility of other macroeconomic variables. Exchange rates are a puzzle not just because they are volatile, but also because they seem to be ‘disconnected’ from the real economy, as discussed by Obstfeld and Rogoff (2000), and Duarte and Stockman (2001).3 Given these prerequisites for explaining exchange rate volatility, the paper constructs a model in which a combination of three factors is key in generating exchange rate volatility that is much higher than the volatility in underlying macroeconomic shocks, or the volatility in other endogenous macroeconomic variables. The first factor is the presence of local currency pricing: exchange rate changes do not pass through to goods prices in the short run. The second feature is the presence of heterogeneity in the way that products are sold and prices are set in international commodity markets. We assume that some firms market their products directly in their export market, but others use foreign distributors. When an exporting firm uses a foreign distributor, it sets the price in its own currency. The distributor takes on the exchange rate risk—buying goods priced in the exporter's currency, and selling in the consumers’ currency. In those cases, a home currency depreciation bestows a positive wealth shock on the distributor. We posit that exporters are more likely to set up foreign offices and undertake their own distributing activities for large consumer markets, but they are more likely to sell to firms that specialize in distributing for sales to smaller markets. We show that under this configuration, the wealth effects of foreign exchange rate changes are minimized, potentially generating very high exchange rate volatility even for small shocks. Finally, however, even with this structure of price setting and international commodity distribution, the degree of exchange rate volatility is restricted by arbitrage in international assets markets. When we allow for trade in non-contingent nominal bonds across countries, unanticipated movements in the exchange rate (in the presence of local currency pricing) generate a real interest rate differential across countries that itself tends to restrict the movement of the exchange rate. But this channel depends critically on the uncovered interest rate parity (UIRP) condition, which (aside from a negligible risk-premium term) continues to hold in a model of local currency pricing and heterogeneity in international goods distribution. In light of this, we extend our model to allow for the presence of foreign currency traders whose expectations of future exchange rates are conditionally biased. In this, we follow closely the recent paper of Jeanne and Rose (2002), showing how ‘noise-traders’ can generate high exchange rate volatility in a monetary model of the exchange rate. Our results show that the presence of all three factors—local currency pricing, heterogeneous international distribution of commodities, and ‘noise traders’ in foreign exchange markets—can potentially generate a high-frequency volatility of the exchange rate that is completely out of proportion to the underlying monetary shocks to the economy. Moreover, while exchange rate volatility is ultimately tied to volatility in the fundamental shocks to the economy, the exchange rate can display extremely high volatility without any implications for the volatility of other macroeconomic variables. We find that the volatility of consumption, GDP, the real interest rate, and the current account may be quite low (of the same order of magnitude as fundamentals), while at the same time the volatility of the exchange rate may be much, much higher. In this sense, the exchange rate becomes ‘disconnected’ from the real economy. The paper is organized as follows. In Section 1, we develop a baseline two-country general equilibrium model that is used throughout the paper. In that section we also show in detail why the assumption of complete international assets markets cannot provide an empirical explanation for exchange rate volatility. In Section 2, we illustrate the determination of the exchange rate under incomplete markets, local currency pricing, and heterogeneous international distribution in commodity markets. In order to develop the intuition, we restrict ourselves simply to a one-period horizon in that section, however. Section 3 extends the model to a dynamic (infinite horizon) environment, introducing a role for ‘noise traders’ in foreign exchange markets.

This paper has made an attempt at developing a fully specified general equilibrium model of the exchange rate which accords with the conjecture of Krugman (1989) that exchange rate volatility is extreme because fluctuations in the exchange rate matter so little for the economy. We show that a combination of local currency pricing, heterogeneity in international price-setting and goods distribution, and expectational biases in international financial markets may combine to produce very high exchange rate volatility without any implications for the volatility of other macroeconomic aggregates. We have developed testable hypotheses about the nature of exchange rate volatility and exchange rate disconnect. In particular, there ought to be a greater disconnect when the degree of local-currency pricing is high and the wealth effects of exchange rate changes are small. But ours is not a fully developed model that is capable of matching all of the empirical features of exchange rates. In particular, in order to explain not just real exchange rate volatility but also persistence, we might want to have more persistent price setting, and perhaps endogenous capital accumulation. We could pay more attention to the underlying incentives that exporting firms have to set up foreign distribution networks, and the pricing structure they use in conjunction with this. We have focused on the extreme case in which there is no expenditure-switching effect of exchange rate changes, but a more realistic model would allow for some substitution possibilities. With respect to the presence of expectational errors in financial markets, we could explore in more detail the microeconomic foundations of noise traders. We have merely clarified what type of deviation from UIRP is necessary to generate very high exchange rate volatility in face of local currency pricing and heterogeneous distribution of products. Nevertheless, our results suggest a number of key elements that may be part of the ‘exchange rate disconnect’ puzzle.