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DSGE Models of High Exchange-Rate Volatility and Low Pass-Through

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  • Giancarlo Corsetti
  • Luca Dedola
  • Sylvain Leduc

Abstract

This paper develops a quantitative, dynamic, open-economy model which endogenously generates high exchange rate volatility, whereas a low degree of pass-through stems from both nominal rigidities (in the form of local currency pricing) and price discrimination. We model real exchange rate volatility in response to real shocks by reconsidering and extending two approaches suggested by the quantitative literature (one by Backus Kehoe and Kydland [1995], the other by Chari, Kehoe and McGrattan [2003]), within a common framework with incomplete markets and segmented domestic economies. Our model accounts for a variable degree of ERPT over different horizons. In the short run, we find that a very small amount of nominal rigidities - consistent with the evidence in Bils and Klenow [2004] - lowers the elasticity of import prices at border and consumer level to 27% and 13%, respectively. Remarkably, exchange rate depreciation worsens the terms of trade - in accord to the evidence stressed by Obstfeld and Rogo [2000]. In the long run, exchange-rate pass-through coefficients are also below one, as a result of price discrimination. The latter is an implication of distribution services, which makes the goods demand elasticity market specific.

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Bibliographic Info

Paper provided by European University Institute in its series Economics Working Papers with number ECO2005/23.

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Date of creation: 2005
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Handle: RePEc:eui:euiwps:eco2005/23

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Keywords: international business cycle; exchange rate volatility; pass-through; international transmission; DSGE models;

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  1. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1993. "International Business Cycles: Theory and Evidence," Working Papers 93-21, New York University, Leonard N. Stern School of Business, Department of Economics.
  2. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 947-985, October.
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  7. Luca Dedola & Sylvain Leduc, 2001. "Why Is the Business-Cycle Behavior of Fundamentals Alike Across Exchange-Rate Regimes?," Working Papers 53, Oesterreichische Nationalbank (Austrian Central Bank).
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