Whom or what do flexible exchange rates insulate?
University of Bonn (joint work with Giancarlo Corsetti, Gernot J. Müller and Sebastian Schmidt)
We reassess whether flexible exchange rates provide insulation against foreign shocks.
First, we establish new evidence for 20 countries in the periphery of the euro area. We find robust evidence for spillovers from euro-area shocks to real activity in the periphery, irrespective of whether the exchange rate is pegged or flexible vis-a-vis the euro. Second, we provide a rationale why the exchange-rate regime appears to have little bearing on international spillovers. We employ a New Keynesian open economy model, in which both exports and imports are priced in euros. Flexible exchange rates could insulate domestic activity from external shocks. The key to understanding the empirical facts is that countries do not choose to do so, however. We show that if floaters pursue inflation targeting (be it of consumer or producer prices), they prevent the domestic expenditure switching that would insulate activity from shocks. The global move toward inflation targeting may mask the insulation potential of flexible exchange rates.
We are looking forward to seeing you there.
Ana Paula Ribeiro and Pedro Gil
“Cef.up is financed by Portuguese public funds through FCT - Fundação para a Ciência e a Tecnologia, I.P., in the framework of the project UID/ECO/04105/2019