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Information frictions and real exchange rate dynamics

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  • Candian, Giacomo

Abstract

Real exchange rates are highly volatile and persistent. I provide a novel structural explanation for these facts using a model with dispersed information among firms. When producers face strategic complementarities in price-setting, uncertainty about competitors' beliefs results in sluggish price adjustment that can generate large and long-lived real exchange rate movements. I estimate the model using data from the US and Euro Area, and show that it successfully explains the unconditional volatility and persistence of the real exchange rate. The model also accounts for the persistent and hump-shaped real exchange rate behavior conditional on nominal disturbances documented by a structural VAR. About 50% of this persistence is due to the inertial dynamics of higher-order beliefs.

Suggested Citation

  • Candian, Giacomo, 2019. "Information frictions and real exchange rate dynamics," Journal of International Economics, Elsevier, vol. 116(C), pages 189-205.
    • Handle: RePEc:eee:inecon:v:116:y:2019:i:c:p:189-205
    DOI: 10.1016/j.jinteco.2018.11.006
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    More about this item

    Keywords

    Real Exchange Rates; Strategic Complementarities; Dispersed Information; Bayesian Estimation;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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