A Real Exchange Rate Based Phillips Curve
AbstractIt has been noted in many papers that primary commodity exporting economies and developing countries frequently respond to movements in the real exchange rate as part of their monetary policies. For many central banks, this variable is the primary indicator of real activity. At the same time, smoothing the real exchange rate fluctuations has certain inflationary costs. In a way, this trade-off between inflation and the real exchange rate is identical to a standard Phillips curve. This paper derives an exact theoretical expression for this “real exchange rate based Phillips curve,” and finds empirical support for its existence in the data for a number of primary commodity exporting economies such as Australia, Canada, New Zealand and others. It turns out that the correct right-hand-side variable in the Phillips curve is not the real exchange rate itself, but rather its deviation from the fundamental value, which is a function of the international price of exported commodities. The empirical counterpart of the fundamental real exchange rate is obtained from a cointegrating equation for the real exchange rate and the countryspecific price index of exported commodities. As is frequently found in other Phillips curve studies, empirical tests point towards the accelerationist specification, which can be rationalized by dominance of adaptive expectations in price-setting behavior.
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Bibliographic InfoPaper provided by Center for Economic and Financial Research (CEFIR) in its series Working Papers with number w0179.
Length: 41 pages
Date of creation: Oct 2012
Date of revision:
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Real exchange rate; inflation; Phillips curve; commodity currencies;
Find related papers by JEL classification:
- 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
- F31 - International Economics - - International Finance - - - Foreign Exchange
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-10-20 (All new papers)
- NEP-MAC-2012-10-20 (Macroeconomics)
- NEP-MON-2012-10-20 (Monetary Economics)
- NEP-OPM-2012-10-20 (Open Economy Macroeconomics)
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