Our setup allows us to disentan- gle the implications of these two alternative pricing mechanisms that are standard in the open-economy macro literature. In our model, di®erent assumptions regarding the pricing decisions of ¯rms are virtually inconsequential for the properties of aggregate variables, other than the terms of trade. In particular, the real exchange rate and the international relative price of ¯nal tradable goods behave similarly across the two price setting regimes. This result follows from the fact that trade represents a relatively small fraction of GDP and that the behavior of the nominal exchange rate is close to a random walk. The two pricing assumptions di®er with.
