Competitive devaluations: toward a welfare-based approach

This paper revisits the international transmission of exchange rate shocks in a multicountry economy, providing a choice-theoretic framework for the p olicy analysis of competitive devaluations. As opposed to the traditional v iew, a devaluation by one country does not necessarily have an adverse begg ar-thy-neighbor effect on its trading partners, because they can benefit fr om an improvement in their terms of trade. Furthermore, a retaliatory deval uation need not be the optimal strategy for the neighbor countries, as the induced terms of trade deterioration can be large enough to offset the gain s from defending their export market share.