An important puzzle in internatio nal macroeconomics is the exchange rate disconnect puzzle. Nominal exchange rates seem to be unrelated to other macroeconomic variables, for example, export quantities. This paper uses Japanese firm level data to examine whether exchange rate fluctuations are strongly related to the export quantities of firms. We build a simultaneous nonlinear structural model with external financing costs, and estimate the model on 14 separate Japanese 4 digit level industries. We find that export volumes at the firm level are significantly affected by exchange rate fluctuations. We find higher elasticit ies of exports with respect to exchange rates than in previous work. Our results cast some doubt on the prevailing wisdom that exchange rates have no effect on trade. Finally, we find in our data that financing constraints play an important role in affecting the sensitivity of exports to exchange rate fluctuations. Firms that are less financially constrained −for example, keiretsu firms− tend to have lower exchange rate elasticities, which is consistent with our model.

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When financial markets are global, the impacts of national banking regulations extend beyond national borders. While lax regulatory enforcement improves the profitability of home banks, it also increases loan supply, which in turn reduces the global interest rate spreads. In a two-country model we show that each regulator's enforcement choice is affected by the relative size of the national financial market. An authority regulating a smaller market has a smaller impact on global interest rates and therefore a stronger incentive to relax regulatory enforcement.

We investigate what accounts for the different evidence between the aggregate and firm-level data on the exchange rate elasticity of exports. The typical estimation of the macroeconomic export equations gives insignificant estimates for this elasticity compared to those from the recent firm-level estimation. Using firm-level data from Japan, we identify the sources of this discrepancy, and show that the failure to account for cost and demand factors as well as firm-level productivity induces various kinds of biases for the aggregate estimate of the exchange rate elasticity of exports.