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Understanding Real Exchange Rate Movements with Trade in Intermediate Products

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  • Parsley, David
  • Popper, Helen

Abstract

We suggest it may be "too easy" to attribute real exchange rate movements to law of one price deviations. We show that it is immaterial whether one uses seemingly traded goods, nontraded goods, or even just a single, unimportant consumer good, say beer. The ease of attributing the variation to any such deviations is explained using a model with intermediate goods trade. In the model, the stage of production determines the traded/nontraded distinction. We find empirical substantiation for the model: law of one price deviations lose explanatory power; and - defined appropriately in terms of intermediate goods - relative prices matter.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 21117.

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Date of creation: Feb 2009
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Handle: RePEc:pra:mprapa:21117

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Keywords: Real Exchange Rates; PPP; MSE decomposition;

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References

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  1. David C. Parsley, 2001. "Accounting for Real Exchange Rate Changes in East Asia," Working Papers, Hong Kong Institute for Monetary Research 062001, Hong Kong Institute for Monetary Research.
  2. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," International Trade, EconWPA 0012003, EconWPA.
  3. Enrique G. Mendoza, 2005. "Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies," NBER Working Papers 11691, National Bureau of Economic Research, Inc.
  4. Haroon Mumtaz & Jean Imbs & Morten O. Ravn & Helene Rey, 2003. "PPP Strikes Back," IMF Working Papers, International Monetary Fund 03/68, International Monetary Fund.
  5. Shiu-Sheng Chen & Charles Engel, 2005. "Does 'Aggregation Bias' Explain The Ppp Puzzle?," Pacific Economic Review, Wiley Blackwell, Wiley Blackwell, vol. 10(1), pages 49-72, 02.
  6. Maurice Obstfeld., 2001. "International Macroeconomics: Beyond the Mundell-Fleming Model," Center for International and Development Economics Research (CIDER) Working Papers, University of California at Berkeley C01-121, University of California at Berkeley.
  7. Obstfeld, Maurice & Rogoff, Kenneth, 1999. "New Directions for Stochastic Open Economy Models," Center for International and Development Economics Research, Working Paper Series, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkele qt5pf7g8sh, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
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  9. Michael Devereux & Charles Engel & Cedric Tille, 1999. "Exchange-Rate Pass-Through and the Welfare Effects of the Euro," Working Papers, University of Washington, Department of Economics 0034, University of Washington, Department of Economics.
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  11. Engel, C., 1996. "Long-Run PPP May Not Hold After All," Working Papers, University of Washington, Department of Economics 96-05, University of Washington, Department of Economics.
  12. Ariel Burstein & Martin Eichenbaum & Sergio Rebelo, 2004. "Large Devaluations and the Real Exchange Rate," NBER Working Papers 10986, National Bureau of Economic Research, Inc.
  13. Charles Engel, 1995. "Accounting for U.S. Real Exchange Rate Changes," NBER Working Papers 5394, National Bureau of Economic Research, Inc.
  14. Alan M. Taylor, 2000. "Potential Pitfalls for the Purchasing-Power-Parity Puzzle? Sampling and Specification Biases in Mean-Reversion Tests of the Law of One Price," NBER Working Papers 7577, National Bureau of Economic Research, Inc.
  15. Giancarlo Corsetti & Luca Dedola, 2002. "Macroeconomics of international price discrimination," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 461, Bank of Italy, Economic Research and International Relations Area.
  16. Jean Imbs & Haroon Mumtaz & Morten O. Ravn & Helene Rey, 2003. "PPP Strikes Back: Aggregation and the Real Exchange Rate," IEHAS Discussion Papers, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences 0307, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences.
  17. Frankel, Jeffrey A, 1984. "The Theory of Trade in Middle Products: An Extension," American Economic Review, American Economic Association, American Economic Association, vol. 74(3), pages 485-87, June.
  18. Ganguly, Srideep & Breuer, Janice Boucher, 2010. "Nominal exchange rate volatility, relative price volatility, and the real exchange rate," Journal of International Money and Finance, Elsevier, Elsevier, vol. 29(5), pages 840-856, September.
  19. Campa, José Manuel & Goldberg, Linda S, 2004. "Exchange Rate Pass-Through into Import Prices," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4391, C.E.P.R. Discussion Papers.
  20. Jose Manuel Campa & Linda S. Goldberg, 2006. "Distribution margins, imported inputs, and the sensitivity of the CPI to exchange rates," Staff Reports, Federal Reserve Bank of New York 247, Federal Reserve Bank of New York.
  21. David C. Parsley & Shang-Jin Wei, 2000. "Explaining the Border Effect: The Role of Exchange Rate Variability, Shipping Costs, and Geography," NBER Working Papers 7836, National Bureau of Economic Research, Inc.
  22. Breuer, Janice Boucher & Lippert, Alston Flynn, 1997. "Internal Relative Price Stationarity in Long-Run Purchasing Power Parity," Review of International Economics, Wiley Blackwell, Wiley Blackwell, vol. 5(2), pages 195-203, May.
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Cited by:
  1. Waldyr Areosa & Marta Areosa, 2012. "The Signaling Effect of Exchange Rates: pass-through under dispersed information," Working Papers Series, Central Bank of Brazil, Research Department 282, Central Bank of Brazil, Research Department.
  2. Emi Nakamura & Dawit Zerom, 2009. "Accounting for Incomplete Pass-Through," NBER Working Papers 15255, National Bureau of Economic Research, Inc.
  3. Yin-Wong Cheung & Menzie D. Chinn & Eiji Fujii, 2010. "Measuring Renminbi Misalignment: Where Do We Stand?," Working Papers, Hong Kong Institute for Monetary Research 242010, Hong Kong Institute for Monetary Research.
  4. Yin-Wong Cheung & Menzie D. Chinn & XingWang Qian, 2012. "Are Chinese Trade Flows Different?," NBER Working Papers 17875, National Bureau of Economic Research, Inc.
  5. Anthony Landry & Mario Crucini, 2010. "Accounting for Real Exchange Rates using Micro-Data," 2010 Meeting Papers, Society for Economic Dynamics 1100, Society for Economic Dynamics.

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