The Responsiveness of Consumer Prices to Exchange Rates: A Synthesis Of Some New Open Economy Macro Models

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Abstract
General equilibrium optimizing models with sticky nominal prices allow us to revisit questions about optimal monetary policy in open economies. If nominal prices are set in producers’ currencies, appropriate monetary policy can reproduce the allocations under flexible prices. If nominal prices are set in consumers’ currencies, stable nominal exchange rates may be desirable. In this case, a nominal exchange rate fixed at the purchasing power parity level can have desirable consequences for risk sharing, and nominal exchange rate flexibility cannot deliver optimal relative price changes. However, evidence shows that pass–through may be greater to import prices than to consumer prices. If prices are fixed for consumers, but importer–distributors face pass–through, then monetary policy–makers face a trade–off that might require some control of nominal exchange rates, but not purely fixed rates.

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