The data show large and persistent deviations of real exchange rates from purchasing power parity. Recent work has shown that to a large extent these movements are driven by deviations from the law of one price for traded goods. In the data, real and nominal exchange rates are about 6 times as volatile as relative price levels and they both are highly persistent, with serial correlations of 0.85 and 0.83, respectively. This paper develops a sticky price model with price discriminating monopolists, which produces deviations from the law of one price for traded goods. Our benchmark model, which has prices set for one quarter at a time and a unit consumption elasticity of money demand, does not come close to reproducing these observations. A model which has producers setting prices for 6 quarters at a time and a consumption elasticity of money demand of 0.27 does much better. In it real and nominal exchange rates are about 3 times as volatile as relative price levels and exchange rates are persistent, with serial correlations of 0.65 and 0.66, respectively.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
5876.
Length: Date of creation: Jan 1997 Date of revision: Handle: RePEc:nbr:nberwo:5876
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Find related papers by JEL classification: F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics F31 - International Economics - - International Finance - - - Foreign Exchange
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Laurence M. Ball & David Romer, 1989.
"Are Prices Too Sticky?,"
NBER Working Papers
2171, National Bureau of Economic Research, Inc.
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