The Federal Reserve Bank of New York works to promote sound and well-functioning financial systems and markets through its provision of industry and payment services, advancement of infrastructure reform in key markets and training and educational support to international institutions.
Regional & Community Outreach connects the Bank to Main Street via structured dialogues and two-way conversations on small business, mortgages, and household credit.
Economic Education improves public knowledge about the Federal Reserve System, monetary policy implementation, and promoting financial stability through the Museum and programs for K-16 students and educators, and the community.
Competitive Devaluations: A Welfare-Based Approach
January 1999Number 58
JEL classification: F31, F32, F41, F42
Authors: Giancarlo Corsetti, Paolo Pesenti, Nouriel Roubini, and Cédric Tille
This paper studies the mechanism of international transmission of exchange rate shocks within a three-country Center-Periphery model, providing a choice-theoretic framework for the policy analysis and empirical assessment of competitive devaluations. If relative prices and terms of trade exhibit some flexibility conforming to the law of one price, a devaluation by one country is beggar-thy-neighbor relative to another country through its effects on cost-competitiveness in a third market. Yet, due to direct bilateral trade between the two countries, there is a large range of parameter values for which a country is better off by maintaining a peg in response to its partner's devaluation. If instead deviations from the law of one price are to be considered the dominant empirical paradigm, then the beggar-thy-neighbor effect based on competition in a third market may disappear. However, a country's devaluation has a negative welfare impact on the economies of its trading partners based on the deterioration of their export revenues and profits and the increase in disutility from higher labor effort for any level of consumption.
For a published version of this report, see Giancarlo Corsetti, Nouriel Roubini, Paolo Pesenti, and Cédric Tille, "Competitive Devaluations: Toward a Welfare-Based Approach," Journal of International Economics51, no. 1 (June 2000): 217-41.