Keeping up with the Joneses and exchange rate volatility in a Redux model

• Published in: International review of economics & finance 2014-01, Vol.29, p.569-584
• Main Authors: Chang, Ming-Jen, Chang, Juin-Jen, Shieh, Jhy-Yuan
• Format: Article
• Language: English
• Subjects: Consumption; Consumption externality; Economic models; Exchange rate volatility; Externality; Foreign exchange rates; Keeping up with the Joneses; Studies; Volatility
• ISSN: 1059-0560; 1873-8036
• DOI: 10.1016/j.iref.2013.08.004

By incorporating a keeping-up-with-the-Joneses preference into the Redux model, this paper sketches the implications of consumption externalities for the short-run and long-run equilibria. We show that the size of the consumption externality plays a crucial role in terms of affecting the long-run and short-run effects of important economic variables. Keeping-up-with-the-Joneses in relation to domestic benchmark consumption has the effect of magnifying the impact of monetary shocks on the exchange rate. Besides, simple numerical analyses show that the exchange rate volatility is raised (reduced) by an increasing rate as the size of the externality in regard to domestic (foreign) consumption increases. •This paper sketches the implications of a consumption externality for the equilibria.•There is no exchange rate overshooting in the presence of keeping up with the Joneses.•Keeping up with the Joneses has the effect of monetary shocks on the exchange rates.•It increases the ability of monetary shocks to explain high volatility in exchange rates.