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DSGE Models of High Exchange-Rate Volatility and Low Pass-Through

  • Giancarlo Corsetti
  • Luca Dedola
  • Sylvain Leduc

This paper develops a quantitative, dynamic, open-economy model which endogenously generates high exchange rate volatility, whereas a low degree of pass-through stems from both nominal rigidities (in the form of local currency pricing) and price discrimination. We model real exchange rate volatility in response to real shocks by reconsidering and extending two approaches suggested by the quantitative literature (one by Backus Kehoe and Kydland [1995], the other by Chari, Kehoe and McGrattan [2003]), within a common framework with incomplete markets and segmented domestic economies. Our model accounts for a variable degree of ERPT over different horizons. In the short run, we find that a very small amount of nominal rigidities - consistent with the evidence in Bils and Klenow [2004] - lowers the elasticity of import prices at border and consumer level to 27% and 13%, respectively. Remarkably, exchange rate depreciation worsens the terms of trade - in accord to the evidence stressed by Obstfeld and Rogo [2000]. In the long run, exchange-rate pass-through coefficients are also below one, as a result of price discrimination. The latter is an implication of distribution services, which makes the goods demand elasticity market specific.

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Paper provided by European University Institute in its series Economics Working Papers with number ECO2005/23.

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Date of creation: 2005
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Handle: RePEc:eui:euiwps:eco2005/23
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  1. Ronald MacDonald & Luca Antonio Ricci, 2001. "PPP and the Balassa Samuelson Effect; The Role of the Distribution Sector," IMF Working Papers 01/38, International Monetary Fund.
  2. Dedola, Luca & Leduc, Sylvain, 2001. "Why Is the Business-Cycle Behaviour of Fundamentals Alike across Exchange-Rate Regimes?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 6(4), pages 401-19, October.
  3. T. Bayoumi & D. Laxton & P. Pesenti, 2003. "When leaner isn't meaner: measuring the benefits and spillovers of greater competition in Europe," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  4. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2005. "International risk-sharing and the transmission of productivity shocks," International Finance Discussion Papers 826, Board of Governors of the Federal Reserve System (U.S.).
  5. Mark Bils & Peter J. Klenow, 2002. "Some Evidence on the Importance of Sticky Prices," NBER Working Papers 9069, National Bureau of Economic Research, Inc.
  6. Corsetti, Giancarlo & Dedola, Luca, 2003. "Macroeconomics of International Price Discrimination," CEPR Discussion Papers 3710, C.E.P.R. Discussion Papers.
  7. Anderton, Robert, 2003. "Extra-euro area manufacturing import prices and exchange rate pass-through," Working Paper Series 0219, European Central Bank.
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