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Real Exchange Rate Volatility and the Price of Nontradable Goods in Economies Prone to Sudden Stops

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  • Enrique G. Mendoza

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Abstract

The dominant view in the empirical literature on exchange rates is that the high variability of real exchange rates is due to movements in exchange-rate-adjusted prices of tradable goods. This paper shows that this dominant view does not hold in Mexican data for the periods in which the country had managed exchange rate regimes. Variance analysis of a 30-year sample of monthly data shows that movements in the price of nontradables relative to tradables account for up to 70 percent of the variability of the real exchange rate during these periods. The paper proposes a model in which this stylized fact, and the Sudden Stops that accompanied the collapse of Mexico's managed exchange rates, could result from an endogenous amplification mechanism operating via nontradables prices in economies with dollarized liabilities and credit constraints. The key feature of this mechanism is Irving Fisher's debt-deflation process. Numerical evaluation suggests that the Fisherian deflation effects on consumption, the current account, and relative prices dwarf those induced by the standard balance sheet effect typical of the Sudden Stops literature.

Suggested Citation

  • Enrique G. Mendoza, 2005. "Real Exchange Rate Volatility and the Price of Nontradable Goods in Economies Prone to Sudden Stops," ECONOMIA JOURNAL, THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION - LACEA, vol. 0(Fall 2005), pages 103-148, August.
  • Handle: RePEc:col:000425:008658
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    Cited by:

    1. Javier Bianchi, 2011. "Overborrowing and Systemic Externalities in the Business Cycle," American Economic Review, American Economic Association, vol. 101(7), pages 3400-3426, December.
    2. Meza, Felipe & Urrutia, Carlos, 2011. "Financial liberalization, structural change, and real exchange rate appreciations," Journal of International Economics, Elsevier, vol. 85(2), pages 317-328.
    3. Anton Korinek & Damiano Sandri, 2016. "Capital Controls or Macroprudential Regulation?," NBER Chapters,in: NBER International Seminar on Macroeconomics 2015 National Bureau of Economic Research, Inc.
    4. Kumhof, Michael & Yan, Isabel, 2016. "Balance-of-payments anti-crises," Journal of Macroeconomics, Elsevier, vol. 48(C), pages 186-202.
    5. Seoane, Hernán D., 2016. "Parameter drifts, misspecification and the real exchange rate in emerging countries," Journal of International Economics, Elsevier, vol. 98(C), pages 204-215.
    6. Davide Romelli & Cristina Terra & Enrico Vasconcelos, 2014. "Current Account and Real Exchange Rate changes: the Impact of Trade Openness," THEMA Working Papers 2014-10, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    7. Stephanie Schmitt-Grohé & Martín Uribe, 2017. "Adjustment to small, large, and sunspot shocks in open economies with stock collateral constraints," Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 35(82), pages 2-9, April.
    8. Stephanie Schmitt-Grohé & Martín Uribe, 2017. "Adjustment to small, large, and sunspot shocks in open economies with stock collateral constraints," Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 35(82), pages 86-95, April.
    9. Olivier Jeanne & Anton Korinek, 2010. "Managing Credit Booms and Busts: A Pigouvian Taxation Approach," NBER Working Papers 16377, National Bureau of Economic Research, Inc.
    10. David Parsley & Helen Popper, 2010. "Understanding Real Exchange Rate Movements With Trade In Intermediate Products," Pacific Economic Review, Wiley Blackwell, vol. 15(2), pages 171-188, May.
    11. Timothy J. Kehoe & Kim J. Ruhl & Joe Steinberg, 2013. "Global imbalances and structural change in the United States," Staff Report 489, Federal Reserve Bank of Minneapolis.
    12. N'Diaye, Papa & Zhang, Ping & Zhang, Wenlang, 2010. "Structural reform, intra-regional trade, and medium-term growth prospects of East Asia and the Pacific--Perspectives from a new multi-region model," Journal of Asian Economics, Elsevier, vol. 21(1), pages 20-36, February.
    13. repec:chb:bcchec:v:20:y:2017:i:2:p:042-088 is not listed on IDEAS
    14. Enrique G. Mendoza, 2016. "Macroprudential Policy: Promise and Challenges," NBER Working Papers 22868, National Bureau of Economic Research, Inc.
    15. Tiryaki, S. Tolga, 2014. "Sectoral asymmetries in a small open economy," Economic Modelling, Elsevier, vol. 43(C), pages 465-475.
    16. Carlos A. Ibarra, 2013. "Capital Flows and Private Investment in Mexico," Economía Mexicana NUEVA ÉPOCA, , vol. 0(3, Cierre), pages 65-99.
    17. Julian Parra-Polania & Carmiña Vargas, 2015. "Optimal tax on capital inflows discriminated by debt-risk profile," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 22(1), pages 102-119, February.
    18. Siming Liu, 2018. "Government Spending during Sudden Stop Crises," Caepr Working Papers 2018-002 Classification-E, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
    19. Anton Korinek, 2017. "Regulating Capital Flows to Emerging Markets: An Externality View," NBER Working Papers 24152, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Real effective exchange rates; Mexico; Dollarization; Price adjustments;

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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