Uncertainty , exchange rate regimes , and national price levels

Large differences in national price levels exist across countries. In this paper, I develop a general equilibrium model predicting that these differences should be related to countries’ exchange rate regimes. My empirical findings confirm that countries with fixed exchange rate regimes have higher national price levels than countries with flexible regimes. At the disaggregate level, the relationship between exchange rate regimes and national price levels is stronger for nontraded goods than for traded goods. I also find that measuring the misalignment in national price levels around times of regime shifts without considering a break in its equilibrium value results in the overestimation of the true misalignment. JEL Classification: E52, F33, and F41 ∗The views expressed in this paper do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. I would like to thank Rudi Dornbusch, Jaume Ventura, Roberto Rigobon, Paolo Pesenti, Kei-Mu Yi, Cedric Tille, Lucas Llach, John Romalis and Roberto Benelli for their helpful comments and discussions. I also benefitted from the comments of seminar participants at MIT, NYU, and the Federal Reserve Bank of New York. Rachel Polimeni provided excellent research assistance. E-mail: [email protected]