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Do Sticky Prices Increase Real Exchange Rate Volatility at the Sector Level?

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  • Mario J. Crucini
  • Mototsugu Shintani
  • Takayuki Tsuruga

Abstract

We introduce the real exchange rate volatility curve as a useful device to understand the role of price stickiness in accounting for deviations from the Law of One Price at the sector level. In the presence of both nominal and real shocks, the theory predicts that the real exchange rate volatility curve is a U-shaped function of the degree of price stickiness. Using sector-level European real exchange rate data and frequency of price changes, we estimate the volatility curve. The results are consistent with the predominance of real effects over nominal effects. Nonparametric analysis suggests the curve is convex and negatively sloped over the majority of its range. Good-by- good variance decompositions show that the relative contribution of nominal shocks is smaller at the sector level than what previous studies have found at the aggregate level. We conjecture that this is due to significant averaging out of good-specific real microeconomic shocks in the process of aggregation.

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Bibliographic Info

Paper provided by Graduate School of Economics Project Center, Kyoto University in its series Discussion papers with number e-10-004.

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Length: 31 pages
Date of creation: Jul 2010
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Handle: RePEc:kue:dpaper:e-10-004

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Keywords: Real exchange rates; Law of One Price; Sticky prices; Nonparametric test for monotonicity;

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  1. Carlos Carvalho & Fernanda Nechio, 2010. "Aggregation and the PPP puzzle in a sticky-price model," Working Paper Series, Federal Reserve Bank of San Francisco 2010-06, Federal Reserve Bank of San Francisco.
  2. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 112(5), pages 947-985, October.
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  7. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," NBER Working Papers 7869, National Bureau of Economic Research, Inc.
  8. MarioJ. Crucini & Mototsugu Shintani & Takayuki Tsuruga, 2010. "The Law of One Price without the Border: The Role of Distance versus Sticky Prices," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 120(544), pages 462-480, 05.
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  14. Laurent Baudry & Hervé Le Bihan & Patrick Sevestre & Sylvie Tarrieu, 2007. "What do Thirteen Million Price Records have to Say about Consumer Price Rigidity?," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, Department of Economics, University of Oxford, vol. 69(2), pages 139-183, 04.
  15. Mario J. Crucini & Christopher I. Telmer, 2012. "Microeconomic Sources of Real Exchange Rate Variability," NBER Working Papers 17978, National Bureau of Economic Research, Inc.
  16. John H. Rogers, 1998. "Monetary shocks and real exchange rates," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 612, Board of Governors of the Federal Reserve System (U.S.).
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