The Quantitative Importance of the Expenditure-Switching Effect

Abstract

This paper investigates the quantitative importance of the expenditure-switching effect in three small open economies: Australia, Canada and the UK, by developing and estimating a structural sticky-price model nesting both producer currency pricing (PCP) and local currency pricing (LCP) settings. The size of the expenditure-switching effect is determined by the degree of price stickiness, the fraction of firms employing PCP versus LCP, the distribution margin, and the elasticity of substitution between domestic and foreign goods. Our estimation results suggest that the expenditure switching role of the nominal exchange rate is larger for Australia and Canada than for the UK, mainly due to the relatively smaller distribution margins in those two countries.