EXCHANGE-RATE REGIMES AND TRADE PRICES - DOES THE EMS MATTER

The paper investigates the role of exchange rate regimes on the process of trade adjustment. A two-period model of a duopoly with consumer switching costs is constructed. The perception of economic agents regarding exchange rate stability is explicitly introduced. The model is tested using bilateral trade prices data for flows inside and outside the European Monetary System (EMS). Results suggest that a system of pegged rates, like the EMS, although helpful, is not necessary to achieve a smooth process of trade adjustment. Rather than the type of exchange rate regime, it appears that misalignment is the crucial factor.