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Why is the Business-Cycle Behavior of Fundamentals Alike Across Exchange-Rate Regimes?

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  • Luca Dedola

    ()
    (Banca dÂ’Italia, Research Department)

  • Sylvain Leduc

    ()
    (Federal Reserve Bank of Philadelphia)

Abstract

Since the adoption of flexible exchange rates, real exchange rates have been much more volatile than they were under Bretton Woods. However, the volatilities of most other macroeconomic variables have remained approximately unchanged. This poses a puzzle for standard international business cycle models. This paper develops a two-country, two-sector model with nominal rigidities featuring deviations from the law of one price due to firms setting prices in buyers' currencies. By partially insulating goods markets across countries and thus mitigating the international expenditure-switching effect, this pricing behavior is found to considerably dampen the responses of quantities to shocks hitting the economies, therefore helping to account for the puzzle.

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Bibliographic Info

Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 411.

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Date of creation: Aug 2001
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Handle: RePEc:bdi:wptemi:td_411_01

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Keywords: equilibrium business cycle; price-adjustment costs; exchange-rate regimes; exchange-rate volatility; local currency pricing;

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References

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Citations

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Cited by:
  1. Robert Kollmann, 2005. "Macroeconomic effects of nominal exchange rate regimes: new insights into the role of price dynamics," ULB Institutional Repository 2013/7624, ULB -- Universite Libre de Bruxelles.
  2. Reinhart, Carmen & Rogoff, Kenneth, 2004. "The modern history of exchange rate arrangements: A reinterpretation," MPRA Paper 14070, University Library of Munich, Germany.
  3. Robert Kollmann, 2002. "Monetary policy rules in the open economy: effects of welfare and business cycles," ULB Institutional Repository 2013/7628, ULB -- Universite Libre de Bruxelles.
  4. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2005. "DSGE Models of High Exchange-Rate Volatility and Low Pass-Through," CEPR Discussion Papers 5377, C.E.P.R. Discussion Papers.
  5. Stavarek, Daniel, 2013. "Cyclical relationship between exchange rates and macro-fundamentals in Central and Eastern Europe," MPRA Paper 45327, University Library of Munich, Germany.
  6. Reinhart, Carmen, 2002. "A Modern History of Exchange Rate Arrangements: Parallel Markets and Dual and Multiple Exchange Rates," MPRA Paper 13194, University Library of Munich, Germany.
  7. Calderon, Cesar & Kubota, Megumi, 2009. "Does higher openness cause more real exchange rate volatility ?," Policy Research Working Paper Series 4896, The World Bank.
  8. Theptida Sopraseuth, 2003. "Exchange Rate Regimes and International Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(2), pages 338-361, April.
  9. Reinhart, Carmen, 2002. "A Modern History of Exchange Rate Arrangements: Chartbook, 1946-2001," MPRA Paper 13192, University Library of Munich, Germany.
  10. Riccardo Cristadoro & Andrea Gerali & Stefano Neri & Massimiliano Pisani, 2006. "Nominal Rigidities in an Estimated Two Country," Computing in Economics and Finance 2006 162, Society for Computational Economics.
  11. Reinhart, Carmen, 2002. "A Modern History of Exchange Rate Arrangements: The Country Histories, 1946-2001," MPRA Paper 13191, University Library of Munich, Germany.

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