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Why are business cycles alike across exchange-rate regimes?

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Author Info
Luca Dedola
Sylvain Leduc

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Abstract

Since the adoption of flexible exchange rates in the early 1970s, real exchange rates have been much more volatile than they were under Bretton Woods. However, the literature showed that the volatilities of most other macroeconomic variables have not been affected by the change in exchange-rate regime. This poses a puzzle for standard international business cycle models. In this paper, the authors study this puzzle by developing a two-country, two-sector model with nominal rigidities featuring deviations from the law of one price because a fraction of firms set prices in buyers' currencies. The authors show that a model with such building blocks can improve the match between the model and the data across exchange-rate regimes. By partially insulating goods markets across countries and thus mitigating the international expenditure-switching effect, local currency pricing considerably dampens the responses of net exports to shocks hitting the economies therefore helping to account for the puzzle.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 02-11.

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Date of creation: 2002
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Handle: RePEc:fip:fedpwp:02-11

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Keywords: Foreign exchange rates;

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  31. Kollmann, R., 1992. "Consumption, Real Exchange Rates and the Structure of International Asset Markets," Cahiers de recherche 9232, Universite de Montreal, Departement de sciences economiques.
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Przemek Kowalski & Wojciech Paczynski & Lukasz Rawdanowicz, 2003. "Exchange rate regimes and the real sector: a sectoral analysis of CEE Countries," Post-Communist Economies, Taylor and Francis Journals, vol. 15(4), pages 533-555, December. [Downloadable!] (restricted)
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