Consumption home bias and exchange rate behavior

Abstract

This paper studies the response of the nominal exchange rate to monetary shocks in an economy with consumption home bias (CHB) and sticky wages. The importance of accounting for the exchange rate with CHB are twofold. CHB is a consequence of the small open economy assumption when outputs are specialized and fluctuations in the relative price of traded goods generate deviations from purchasing power parity without violating the law of one price. The CHB mechanism allows monetary shocks to generate exchange rate dynamics. However, output is more sensitive to the parameter that governs expenditure switching when there is CHB. Limiting the output response to monetary shocks, whilst still generating exchange rate dynamics, places a stronger emphasis on expenditure shifting, compared to the situation in which deviations from purchasing power parity arise from failures in the law of one price.

Fiscal Policy in a Floating Exchange Rate Regime with Consumption Home Bias

“…In the studies made on the topic of consumption home bias, they mostly focused on the early exploration of the causes of consumption home bias, such as trade costs (Obstfeld & Rogoff, 2000;Ried, 2009), country size and openness (Sutherland, 2005;De Paoli, 2009), non-traded goods (Stockman & Dellas, 1989;Pesenti & Van Wincoop, 2002) as well as trade in intermediate input factors (Hillberry & Hummels, 2002), all are main causes that scholars believe to constitute consumption home bias. More recent studies have focused on discussion on the effect of consumption home bias, such as Pierdzioch (2004) analyzed the effect of monetary shock on different home bias and the extent of capital mobility, Hau (2002), Pitterle and Steffen (2004a;2004b), Kollmann (2004), Sutherland (2005), Leith and Lewis (2006) and Cooke (2010) discussed the effect of home bias on exchange rate fluctuations, De Paoli (2009) discussed the welfare effects of home bias and monetary policy. In addition, it worth mentioning that the effect of home bias on the optimal monetary policy is quite a hot topic recently, which including research made by Faia and Monacelli (2006), Jondeau and Sahuc (2008), Galí and Monacelli (2008) and Wang (2010); obviously, the studies made in respect of consumption home bias were quite enthusiastic, but none of literature up to now can clearly explain the role of home bias on the effects of government expenditure shock.…”

The Effects of Tariff Policy under the Fixed Exchange Rate Regime

“…The study with topic in respect of consumption home bias has mostly focused on discussion of the causes, such as trade costs (Obstfeld and Rogoff, 2000;Ried, 2009), country size and the extent of openness (Sutherland, 2005;De Paoli, 2009), non-traded goods (Stockman and Dellas, 1989;Pesenti and Wincoop, 2002) and trade in intermediate input factor (Hillberry and Hummels, 2002), which are all main causes that scholars believed for consumption home bias. More recent studies have focused on discussion of the effect of home bias, such as Pierdzioch (2004) analyzed the effects of monetary policy on different extent of home bias and the capital mobility, Hau (2002), Pitterle and Steffen (2004), Kollmann (2004), Sutherland (2005), Leith and Lewis (2006) and Cooke (2010) discussed the effect of home bias on the exchange rate fluctuation, while De Paoli (2009) discussed the welfare effects of home bias and monetary policy. In addition, it is worthy to mention that the effect of home bias on the optimal monetary policy is also a quite hot topic, where it includes works by Faia and Monacelli (2006), Jondeau and Sahuc (2008), Galí and Monacelli (2008) and Wang (2010).…”

Fiscal Policy and Macroeconomic Fluctuations in a Fixed Exchange Rate Regime

“…For example, Pierdzioch (2004) studied the effects of monetary shock under consumption. Hau (2002); Kollmann (2004); Sutherland (2005); Leith and Lewis (2006) and Cooke (2010) explored home bias on the effect of exchange rate, Paoli (2009) discussed the welfare effect of monetary policy with consumption home bias. Another issue needs to mention about is home bias on the effect of formulation of the optimal monetary policy, related research including Faia and Monacelli (2006); Jondeau and Sahuc (2008); Gali and Monacelli (2008) and Wang (2010).…”