Short‐Termism and the Dangers of Prior Announcement of Policy When There is Hysteresis in Trade and Competitiveness

It has been suggested recently that, in the presence of non‐zero entry costs and where there is sluggish adjustment, ‘over‐shooting’ of the real exchange rate and ‘short‐termist’ behaviour by firms may exacerbate hysteresis effects in trade and the real exchange rate. The purpose of this paper is to show that, in special circumstances, hysteresis effects may in fact be reduced in these circumstances. In other words, short‐run volatility of the real exchange rate and short‐sighted behaviour may actually dampen trade and exchange rate hysteresis. Furthermore, by pre‐announcing policy, governments may actually worsen hysteresis effects in trade and the real exchange rate.