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Persistent Real Exchange Rates

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  • Alok Johri

    ()
    (Economics McMaster University)

  • Amartya Lahiri

Abstract

This paper revisits three features of the data that are widely known: (a) there exists a high correlation between bilateral nominal and real exchange rates; (b) real exchange rate movements are highly persistent; and (c) real exchange rates are highly volatile. The paper attempts a joint, albeit partial, rationalization of these facts in an environment where prices are preset for only one quarter and there are no staggered contracts. The key innovation is that we augment a standard two-country open economy model with learning-by-doing in production at the firm level. This induces monopolistically competitive firms to endogeneize the productivity effect of their price setting behavior. Specifically, firms endogenously choose not to adjust prices by the full proportion of a positive monetary shock in order to take advantage of the productivity benefits of higher production. We show that the calibrated model can quantitatively reproduce significant fractions of the aforementioned facts.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 281.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:281

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Related research

Keywords: Real exchange rate movements; endogenous price stickiness; learning-by-doing;

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References

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