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302CHAPTER 9. THE NEW INTERNATIONAL MACROECONOMICSSummary of pricing-to-market and comparison to Redux. Manyof the Mundell—Fleming results are restored under pricing to market.Money is neutral in the long run, exchange rate overshooting is restored,real and nominal exchange rates are perfectly correlated in the short runand under reasonable parameter values expansionary monetary policyis a ‘beggar thy neighbor’ policy that raises domestic welfare and lowersforeign welfare.Short-run PPP is violated which means that real interest rates candiffer across countries. Deviations from real interest parity allow imperfectcorrelation between home and foreign consumption. While consumptionco-movements are low, output co-movements are high andthat is consistent with the empirical evidence found in Chapter 5. Thereis no exchange-rate pass-through and there is no expenditure switchingeffect. Exchange rate ßuctuations do not affect relative prices but doaffect relative income. For a given level of output, the depreciationgenerates a redistribution of income by raising the dollar earnings ofdomestic Þrms and reduces the ‘euro’ earnings of foreign Þrms.In the Redux model, the exchange rate response to a monetary shockis inversely related to the elasticity of demand, θ. The substitutabilitybetween domestic and foreign goods is increasing in θ. Higher valuesof θ require a smaller depreciation to generate an expenditure switchof a given magnitude. Substitutability is irrelevant under full pricingto-market.Part of a monetary transfer to domestic residents is spenton foreign goods which causes the home currency to depreciate. Thedepreciation raises domestic Þrm income which reinforces the increasedhome consumption. What is relevant here is the consumption elasticityof money demand 1/².In both Redux and pricing to market, one-period nominal rigiditiesare introduced as an exogenous feature of the environment. This ismathematically convenient because the economy goes to new steadystate in just one period. The nominal rigidities can perhaps be motivatedby Þxed menu costs, and the analysis is relevant for reasonablysmall shocks. If the monetary shock is sufficiently large however, thebeneÞts to immediate adjustment will outweigh the menu costs thatgenerate the stickiness.