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Can sticky price models generate volatile and persistent real exchange rates?

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  • V.V. Chari
  • Patrick J. Kehoe
  • Ellen R. McGrattan

Abstract

The conventional wisdom is that monetary shocks interact with sticky goods prices to generate the observed volatility and persistence in real exchange rates. We investigate this conventional wisdom in a quantitative model with sticky prices. We find that with preferences as in the real business cycle literature, irrespective of the length of price stickiness, the model necessarily produces only a fraction of the volatility in exchange rates seen in the data. With preferences which are separable in leisure, the model can produce the observed volatility in exchange rates. We also show that long stickiness is necessary to generate the observed persistence. In addition, we show that making asset markets incomplete does not measurably increase either the volatility or persistence of real exchange rates. ; Replaced by Staff Report 277

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Bibliographic Info

Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 223.

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Date of creation: 1998
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Handle: RePEc:fip:fedmsr:223

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Keywords: Prices ; Econometric models ; Foreign exchange rates;

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References

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  1. Is Inflation in Argentina Above 100%?
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