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Exchange rate determination in a model of pricing-to-market and nontradeables

  • Hairault, Jean-Olivier
  • Sopraseuth, Thepthida

The international macroeconomic literature attributes the nominal and real exchange rate volatility to two mechanisms. The first one, underlined by Betts and Devereux [1996], lays stress on the deviation from the law of one price due to Pricing-To-Market (PTM) behavior whereas the second mechanism, uncovered by Hau [2000], relies on the presence of non tradables. This paper provides an integrated model with PTM and non tradables. We show that both effects are deeply intertwined. Following an expansion in the relative money supplies, PTM increases exchange rate volatility especially in open economies. Similarly, non tradables magnifies the exchange rate depreciation providing that the law of one price holds for a large share of tradables. Finally, the model suggests that PTM is more important than non tradables in accounting for the high exchange rate volatility.

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Paper provided by CEPREMAP in its series CEPREMAP Working Papers (Couverture Orange) with number 0304.

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Length: 19 pages
Date of creation: 2003
Date of revision:
Handle: RePEc:cpm:cepmap:0304
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  1. Alan C. Stockman & Linda L. Tesar, 1990. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," NBER Working Papers 3566, National Bureau of Economic Research, Inc.
  2. Obstfeld, Maurice & Rogoff, Kenneth S., 1995. "Exchange Rate Dynamics Redux," Scholarly Articles 12491026, Harvard University Department of Economics.
  3. 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.
  4. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September.
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