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

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  • Takayuki Tsuruga

    (Kyoto University)

  • Mototsugu Shintani

    (Vanderbilt University)

  • Mario J. Crucini

    (Vanderbilt University)

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 Society for Economic Dynamics in its series 2011 Meeting Papers with number 784.

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Date of creation: 2011
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Handle: RePEc:red:sed011:784

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  1. V. V Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2002. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," Review of Economic Studies, Oxford University Press, vol. 69(3), pages 533-563.
  2. Carlos Carvalho & Fernanda Nechio, 2008. "Aggregation and the PPP puzzle in a sticky-price model," Staff Reports 351, Federal Reserve Bank of New York.
  3. 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, vol. 69(2), pages 139-183, 04.
  4. Stockman, Alan C, 1980. "A Theory of Exchange Rate Determination," Journal of Political Economy, University of Chicago Press, vol. 88(4), pages 673-98, August.
  5. Jón Steinsson, 2008. "The Dynamic Behavior of the Real Exchange Rate in Sticky Price Models," NBER Working Papers 13910, National Bureau of Economic Research, Inc.
  6. Rogers, John H., 1999. "Monetary shocks and real exchange rates," Journal of International Economics, Elsevier, vol. 49(2), pages 269-288, December.
  7. Paul R. Bergin & Reuven Glick & Jyh-Lin Wu, 2010. "The micro-macro disconnect of purchasing power parity," Working Paper Series 2010-14, Federal Reserve Bank of San Francisco.
  8. Mario J. Crucini & Christopher I. Telmer, 2012. "Microeconomic Sources of Real Exchange Rate Variability," NBER Working Papers 17978, National Bureau of Economic Research, Inc.
  9. 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, vol. 120(544), pages 462-480, 05.
  10. Patrick J. Kehoe & Virgiliu Midrigan, 2007. "Sticky prices and sectoral real exchange rates," Working Papers 656, Federal Reserve Bank of Minneapolis.
  11. Christian Broda & David E. Weinstein, 2008. "Understanding International Price Differences Using Barcode Data," NBER Working Papers 14017, National Bureau of Economic Research, Inc.
  12. Luis J. Álvarez & Ignacio Hernando, 2004. "Price setting behaviour in Spain: stylised facts using consumer price micro data," Banco de Espa�a Working Papers 0422, Banco de Espa�a.
  13. Eichenbaum, Martin & Evans, Charles L, 1995. "Some Empirical Evidence on the Effects of Shocks to Monetary Policy on Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 110(4), pages 975-1009, November.
  14. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 947-985, October.
  15. anonymous, 2004. "The macroeconomics of fiscal policy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 49(Jun).
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