When and How Much Does a Peg Increase Trade The Role of Trade Costs and Import Demand Elasticity under Monetary Uncertainty

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When and How Much Does a Peg Increase Trade? The Role of Trade Costs and Import Demand Elasticity under Monetary Uncertainty Alexander Mihailov? University of Essex April 2004 Abstract This paper extends recent research in stochastic new open-economy macroeconomics (NOEM) to study the e?ects of the exchange-rate regime on international trade in a more realistic, yet rigorous, analytical set-up. We essentially embed trade in similar and di?erent output mixes within a common framework and focus on the implications of impediments to cross-border transactions under alternative invoicing, namely producer's currency pricing (PCP) versus consumer's currency pricing (CCP). Given separable utility and symmetry in structure and in the distributions of national money shocks, the only source of uncertainty in the model, our principal contribution is to show that with (some degree of) PCP — al- though not (full) CCP — a peg slightly reduces expected trade, measured in terms of GDP, relative to a float under elastic import demand. Inelastic import demand, possible under the same taste for diversity but dissimilar outputs arising from di?erences in endowments, reverses this conclusion. JEL Classification: F10, F33, F41. Keywords: international trade costs, import demand elasticity, al- ternative price setting, exchange-rate regimes, stochastic NOEM models. ?I am grateful to Philippe Bacchetta, Hans Genberg, Aude Pommeret and — particularly — Cédric Tille for comments on earlier versions as well as to Giancarlo Corsetti and Philip Lane for discussing related research.

• international trade


• ultimate equilibrium


• rate regime


• exchange rate


• equilibrium trade


• often been


• noem


• when does


• pricing