IDEAS home Printed from
MyIDEAS: Login to save this paper or follow this series

Equilibrium exchange rates and supply-side performance

  • Gianluca Benigno
  • Christoph Thoenissen

A two-country, optimising, sticky price model of real exchange rate determination in the new open macroeconomics tradition is developed, allowing several different forms of deviation from purchasing power parity (PPP), both along the adjustment path and in the steady state. The model has a rich structure, and is designed to provide a flexible tool for policy analysis. Unlike much of the literature, both of the key components of the real exchange rate-the relative price of non-tradables, and the terms of trade-are made endogenous, allowing a more complete analysis of the impact of structural shocks. To illustrate one possible application, the model is calibrated to match key elements of the UK and euro-area economies, and used to examine the extent to which possible improvements in the United Kingdom's relative supply-side performance might account for the sharp and persistent appreciation in sterling since 1996. The results are not supportive of this hypothesis. In the model, improvements in productivity, goods market and labour market competitiveness are all associated with a depreciation in both the spot and the equilibrium real sterling exchange rates. Two potential supply-side sources of an equilibrium appreciation are considered: a productivity improvement biased towards traded goods (Balassa-Samuelson effect); and an anticipated future productivity rise. However, each is insufficient to account for a long-run equilibrium appreciation, although the latter may account for an initial appreciation of the real exchange rate. The paper is concluded by considering further mechanisms that could affect the results.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: no

Paper provided by Bank of England in its series Bank of England working papers with number 156.

in new window

Date of creation: Jun 2002
Date of revision:
Handle: RePEc:boe:boeewp:156
Contact details of provider: Postal: Publications Group Bank of England Threadneedle Street London EC2R 8AH
Phone: +44 (0)171 601 4030
Fax: +44 (0)171 601 5196
Web page:

More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Argia Sbordone, 2002. "An optimizing model of U.S. wage and price dynamics," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  2. Nicoletta Batini & Richard Harrison & Stephen P. Millard, 2001. "Monetary policy rules for an open economy," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  3. Benigno, Pierpaolo, 2001. "Price Stability with Imperfect Financial Integration," CEPR Discussion Papers 2854, C.E.P.R. Discussion Papers.
  4. M.B. Devereux & Ch. Engel, 2003. "Exchange Rate Pass-Through, Exchange Rate Volatility, and ExchangeRate Disconnect," DNB Staff Reports (discontinued) 77, Netherlands Central Bank.
  5. Krugman, Paul, 1989. "Differences in income elasticities and trends in real exchange rates," European Economic Review, Elsevier, vol. 33(5), pages 1031-1046, May.
  6. Benigno, Gianluca, 2004. "Real exchange rate persistence and monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 473-502, April.
  7. Frank Smets & Raf Wouters, 2002. "Monetary policy in an estimated stochastic dynamic general equilibrium model of the Euro area," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  8. Grossman, Gene M & Helpman, Elhanan, 1991. "Quality Ladders in the Theory of Growth," Review of Economic Studies, Wiley Blackwell, vol. 58(1), pages 43-61, January.
  9. Jon Faust & John H. Rogers, 1999. "Monetary policy's role in exchange rate behavior," International Finance Discussion Papers 652, Board of Governors of the Federal Reserve System (U.S.).
  10. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  11. King, Robert G & Watson, Mark W, 1998. "The Solution of Singular Linear Difference Systems under Rational Expectations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 1015-26, November.
  12. Obstfeld, Maurice & Rogoff, Kenneth, 2000. "New directions for stochastic open economy models," Journal of International Economics, Elsevier, vol. 50(1), pages 117-153, February.
  13. Taylor, John B. (ed.), 2001. "Monetary Policy Rules," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226791258, December.
  14. McCallum, Bennett T. & Nelson, Edward, 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Seminar Papers 644, Stockholm University, Institute for International Economic Studies.
  15. Robert Feenstra & Paul Bergin, 2003. "Pricing To Market, Staggered Contracts, And Real Exchange Rate Persistence," Working Papers 991, University of California, Davis, Department of Economics.
  16. Michael B. Devereux & Charles Engel, 2000. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibility," NBER Working Papers 7665, National Bureau of Economic Research, Inc.
  17. Benigno, Gianluca & Christoph Thoenissen, 2002. "Equilibrium Exchange Rates and Supply Side Performance," Royal Economic Society Annual Conference 2002 19, Royal Economic Society.
  18. Corsetti, Giancarlo & Pesenti, Paolo, 2002. "International Dimensions of Optimal Monetary Policy," CEPR Discussion Papers 3349, C.E.P.R. Discussion Papers.
  19. Lane, P, 1999. "The New Open Economy Macroeconomics: A Survey," Trinity Economics Papers 993, Trinity College Dublin, Department of Economics.
  20. Jordi GalĂ­ & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  21. Engel, C., 1996. "Accounting for U.S. Real Exchange Rate Changes," Discussion Papers in Economics at the University of Washington 96-02, Department of Economics at the University of Washington.
  22. Chari, V V & Kehoe, Patrick J & McGrattan, Ellen R, 2002. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," Review of Economic Studies, Wiley Blackwell, vol. 69(3), pages 533-63, July.
  23. Betts, Caroline & Devereux, Michael B., 1996. "The exchange rate in a model of pricing-to-market," European Economic Review, Elsevier, vol. 40(3-5), pages 1007-1021, April.
  24. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1997. "Monetary Shocks and Real Exchange Rates in Sticky Price Models of International Business Cycles," NBER Working Papers 5876, National Bureau of Economic Research, Inc.
  25. William Poole, 1999. "Monetary policy rules?," Speech 81, Federal Reserve Bank of St. Louis.
  26. Rogers, John H., 1999. "Monetary shocks and real exchange rates," Journal of International Economics, Elsevier, vol. 49(2), pages 269-288, December.
  27. Katharine S. Neiss & Edward Nelson, 2001. "The real interest rate gap as an inflation indicator," Bank of England working papers 130, Bank of England.
  28. Benigno, Gianluca & Benigno, Pierpaolo, 2001. "Monetary Policy Rules and the Exchange Rate," CEPR Discussion Papers 2807, C.E.P.R. Discussion Papers.
  29. Michele Cavallo & Fabio Ghironi, 2000. "Net Foreign Assets and the Exchange Rate: Redux Revived," Boston College Working Papers in Economics 505, Boston College Department of Economics, revised 01 Feb 2002.
  30. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  31. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
  32. Marc P. Giannoni, 2010. "Optimal Interest-Rate Rules in a Forward-Looking Model, and Inflation Stabilization versus Price-Level Stabilization," NBER Working Papers 15986, National Bureau of Economic Research, Inc.
  33. Sargent, Thomas J, 1989. "Two Models of Measurements and the Investment Accelerator," Journal of Political Economy, University of Chicago Press, vol. 97(2), pages 251-87, April.
  34. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  35. Cedric Tille & Nicolas Stoffels & Olga Gorbachev, 2001. "To what extent does productivity drive the dollar?," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 7(Aug).
  36. Michael B. Devereux & Charles Engel, 2001. "Endogenous Currency of Price Setting in a Dynamic Open Economy Model," NBER Working Papers 8559, National Bureau of Economic Research, Inc.
  37. Stephen J. Turnovsky, 1997. "International Macroeconomic Dynamics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262201119, June.
  38. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:boe:boeewp:156. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Publications Team)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.