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

Author

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  • Mario J. Crucini

    (Department of Economics, Vanderbilt University)

  • Mototsugu Shintani

    (Department of Economics, Vanderbilt University)

  • Takayuki Tsuruga

    (Graduate School of Economics, Kyoto University)

Abstract

We introduce the real exchange rate volatility curve as a useful device to understand the relationship between price stickiness and the fluctuations in Law of One Price deviations. 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 US-European real exchange rate data and frequency of price changes, we estimate the volatility curve and find the predominance of real effects over nominal effects. 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.

Suggested Citation

  • Mario J. Crucini & Mototsugu Shintani & Takayuki Tsuruga, 2010. "Do Sticky Prices Increase Real Exchange Rate Volatility at the Sector Level?," Vanderbilt University Department of Economics Working Papers 1120, Vanderbilt University Department of Economics.
    • Handle: RePEc:van:wpaper:1120
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    References listed on IDEAS

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    Cited by:

    1. Crucini, Mario J. & Shintani, Mototsugu & Tsuruga, Takayuki, 2015. "Noisy information, distance and law of one price dynamics across US cities," Journal of Monetary Economics, Elsevier, vol. 74(C), pages 52-66.
    2. Elberg, Andrés, 2016. "Sticky prices and deviations from the Law of One Price: Evidence from Mexican micro-price data," Journal of International Economics, Elsevier, vol. 98(C), pages 191-203.
    3. Mallick, Sushanta & Marques, Helena, 2017. "Export prices, selection into exporting and market size: Evidence from China and India," International Business Review, Elsevier, vol. 26(6), pages 1034-1050.
    4. Mario J. Crucini & Mototsugu Shintani & Takayuki Tsuruga, 2020. "A Behavioral Explanation for the Puzzling Persistence of the Aggregate Real Exchange Rate," NBER Working Papers 27420, National Bureau of Economic Research, Inc.
    5. Lein‐Lein Chen & Seungmook Choi & John Devereux, 2015. "Explaining price level differences: New evidence on the Balassa–Samuelson effect," Southern Economic Journal, John Wiley & Sons, vol. 82(1), pages 81-99, July.
    6. Nakamura, Fumitaka, 2022. "The origin of the law of one price deviations: Insights from the good-level real exchange rate volatility," Journal of International Money and Finance, Elsevier, vol. 128(C).

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    More about this item

    Keywords

    Real exchange rates; Law of One Price; Sticky prices; Nonparametric test for monotonicity;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General

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