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U.S. real exchange rate fluctuations and relative price fluctuations

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  • Caroline M. Betts
  • Timothy J. Kehoe

Abstract

This paper studies the relation between the United States? bilateral real exchange rate and the associated bilateral relative price of nontraded goods for five of its most important trade relationships. Traditional theory attributes fluctuations in real exchange rates to changes in the relative price of nontraded goods. We find that this relation depends crucially on the choice of price series used to measure relative prices and on the choice of trade partner. The relation is stronger when we measure relative prices using producer prices rather than consumer prices. The relation is stronger the more important is the trade relationship between the United States and a trade partner. Even in cases where there is a strong relation between the real exchange rate and the relative price of nontraded goods, however, a large fraction of real exchange rate fluctuations is due to deviations from the law of one price for traded goods.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 334.

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Date of creation: 2004
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Publication status: Published in Journal of Monetary Economics> (Vol. 53, No. 7, October 2006, pp. 1297-1326)
Handle: RePEc:fip:fedmsr:334

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Keywords: Foreign exchange rates ; Prices ; International trade ; International finance ; Monetary policy;

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  1. Maurice Obstfeld., 2001. "International Macroeconomics: Beyond the Mundell-Fleming Model," Center for International and Development Economics Research (CIDER) Working Papers C01-121, University of California at Berkeley.
  2. Lapham, Beverly J., 1995. "A dynamic general equilibrium analysis of deviations from the laws of one price," Journal of Economic Dynamics and Control, Elsevier, vol. 19(8), pages 1355-1389, November.
  3. Caroline M. Betts & Timothy J. Kehoe, 2008. "Real Exchange Rate Movements and the Relative Price of Non-traded Goods," NBER Working Papers 14437, National Bureau of Economic Research, Inc.
  4. Alan C. Stockman & Linda L. Tesar, 1990. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," NBER Working Papers 3566, National Bureau of Economic Research, Inc.
  5. Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, vol. 72, pages 584.
  6. Ariel Burstein & Martin Eichenbaum & Sergio Rebelo, 2002. "Why Are Rates of Inflation So Low After Large Devaluations?," NBER Working Papers 8748, National Bureau of Economic Research, Inc.
  7. Charles Engel & John H. Rogers, 1995. "How wide is the border?," Research Working Paper 95-09, Federal Reserve Bank of Kansas City.
  8. Mario J. Crucini & Chris I. Telmer & Marios Zachariadis, 2001. "Understanding European Real Exchange Rates," Vanderbilt University Department of Economics Working Papers 0120, Vanderbilt University Department of Economics.
  9. Chari, V V & Kehoe, Patrick J & McGrattan, Ellen R, 2002. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," Review of Economic Studies, Wiley Blackwell, vol. 69(3), pages 533-63, July.
  10. Charles Engel, 1992. "Real Exchange Rates and Relative Prices: An Empirical Investigation," NBER Working Papers 4231, National Bureau of Economic Research, Inc.
  11. Imbs, Jean & Mumtaz, Haroon & Ravn, Morten O. & Rey, Hélène, 2003. "PPP Strikes Back: Aggregation and the Real Exchange Rate," CEPR Discussion Papers 3715, C.E.P.R. Discussion Papers.
  12. Kravis, Irving B. & Lipsey, Robert E., 1978. "Price behavior in the light of balance of payments theories," Journal of International Economics, Elsevier, vol. 8(2), pages 193-246, May.
  13. Rebelo, S. & Vegh, C.A., 1995. "Real Effects of Exchange-Rate-Based Stabilization: An Analysis of Competing Theories," RCER Working Papers 405, University of Rochester - Center for Economic Research (RCER).
  14. Engel, C., 1996. "Accounting for U.S. Real Exchange Rate Changes," Discussion Papers in Economics at the University of Washington 96-02, Department of Economics at the University of Washington.
  15. Rogers, J.H. & Jenkins, M.A., 1993. "Haircuts or Hysteresis? Sources of Movements in Real Exchange Rates," Papers 4-93-6, Pennsylvania State - Department of Economics.
  16. de Cordoba, Gonzalo Fernandez & Kehoe, Timothy J., 2000. "Capital flows and real exchange rate fluctuations following Spain's entry into the European Community," Journal of International Economics, Elsevier, vol. 51(1), pages 49-78, June.
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  1. Is Inflation in Argentina Above 100%?
    by Nicolas Cachanosky in Punto de Vista Economico on 2013-04-25 03:10:38
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