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Persistent Trade Effects of Large Exchage Rate Shocks

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  • Richard Baldwin
  • Paul R. Krugman

Abstract

This paper presents a theoretical basis fcr the srgunent that large exchange rate shocks - such as the rise of the dollar from 1980 to 1985 - may shift historical relationships between exchange rates and trade flows. We begin with partial models in which large exchange rate fluctuations lead to entry or exit decisions that are not reversed when the currency returns to its previous level. When we develop a simple model of the feedback from "hysteresis" in trade to the exchange rate itself. Here we see that a large capital inflow, which leads to an initial appreciation, can result in a persistent reduction in the exchange rate consistent with trade balance.

Suggested Citation

  • Richard Baldwin & Paul R. Krugman, 1986. "Persistent Trade Effects of Large Exchage Rate Shocks," NBER Working Papers 2017, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:2017
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    1. Baldwin, Richard, 1990. "Hysteresis in Trade," Empirical Economics, Springer, vol. 15(2), pages 127-142.
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