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Exchange Rates and Capital Flows

Paper Session

Friday, Jan. 4, 2019 8:00 AM - 10:00 AM

Atlanta Marriott Marquis, L506
Hosted By: Econometric Society
  • Chair: Alexander Rodnyansky, University of Cambridge

An Equilibrium Model of the International Price System

Dmitry Mukhin
Yale University


The currency in which international prices are set is a factor of fundamental importance in international economics: it determines the benefits of floating versus pegged exchange rates and the spillover effects of monetary policy across economies. However, the standard assumption in existing models - that all prices are set in a currency of either the producer or the consumer - is inconsistent with the dominant status of the dollar in global trade. In this paper, I develop a general equilibrium framework with endogenous currency choice and establish three main results. First, there are strategic complementarities in currency choice across exporters, which can lead to a dominant currency in international trade. The dollar is more likely to play this role because of the large size and the relative stability of the U.S. economy and history dependence. Second, despite small private costs, the invoicing decisions of firms lead to large aggregate spillover effects between countries. I show that in contrast to the standard "currency war" logic, a depreciation of the U.S. exchange rate has a positive effect on output in other economies when international prices are set in dollars. Finally, there are general equilibrium complementarities between firms' currency choice and the optimal monetary policy: because of U.S. spillover effects arising under dollar pricing, it is optimal for other countries to partially peg their exchange rates to the dollar, which in turn stimulates firms to set prices in dollars.

Global Portfolio Rebalancing and Exchange Rates

Nelson Camanho
Catholic University of Portugal
Harald Hau
University of Geneva
Helene Rey
London Business School


We examine international equity allocations at the fund level and show how different
returns on the foreign and domestic proportion of portfolios determine rebalancing behavior and trigger capital flows. We document the heterogeneity of rebalancing across fund types, its greater intensity under higher exchange rate volatility, and the exchange rate e¤ect of such rebalancing. The observed dynamics of equity returns, exchange rates, and fund-level capital flows are compatible with a model of incomplete FX risk trading in which exchange rate risk partially segments international equity markets.

Exchange Rate Shocks and Quality Adjustments

Daniel Goetz
University of Toronto
Alexander Rodnyansky
University of Cambridge


How do firms change the quality composition of their traded goods in response to an exchange rate shock? Using data from a large Russian retailer that varies its offerings at high frequency, we document that ruble devaluations are associated with a reduction in the quality of goods the retailer imports for resale. Our results indicate that an increase in the retailer's costs, as opposed to a reduction in demand due to shrinking real incomes, is the driving force. We estimate a simple model to quantify the welfare impact of quality adjustments and find that preventing firms from downgrading overstates the welfare loss from the 2014 ruble devaluation by 34%, while incorporating cost heterogeneity but ignoring quality has an ambiguous effect on the welfare change.
JEL Classifications
  • F3 - International Finance
  • F4 - Macroeconomic Aspects of International Trade and Finance