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Accounting for real exchange rates using micro-data

  • Mario J. Crucini
  • Anthony E. Landry

The classical dichotomy predicts that all of the time series variance in the aggregate real exchange rate is accounted for by nontraded goods in the CPI basket because traded goods obey the Law of One Price. In stark contrast, Engel (1999) found that traded goods had comparable volatility to the aggregate real exchange. Our work reconciles these two views by successfully applying the classical dichotomy at the level of intermediate inputs into the production of final goods using highly disaggregated retail price data. Since the typical good found in the CPI basket is about equal parts traded and nontraded inputs, we conclude that the classical dichotomy applied to intermediate inputs restores its conceptual value.

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Paper provided by Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 108.

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Date of creation: 2012
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Handle: RePEc:fip:feddgw:108
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  1. Ariel T. Burstein & Joao C. Neves & Sergio Rebelo, 2000. "Distribution Costs and Real Exchange Rate Dynamics During Exchange-Rate-Based Stabilizations," RCER Working Papers 473, University of Rochester - Center for Economic Research (RCER).
  2. Parsley, David & Popper, Helen, 2009. "Understanding Real Exchange Rate Movements with Trade in Intermediate Products," MPRA Paper 21117, University Library of Munich, Germany.
  3. Ariel Burstein & Martin Eichenbaum & Sergio Rebelo, 2005. "Large Devaluations and the Real Exchange Rate," Journal of Political Economy, University of Chicago Press, vol. 113(4), pages 742-784, August.
  4. Charles Engel & John H. Rogers, 1995. "How wide is the border?," Research Working Paper 95-09, Federal Reserve Bank of Kansas City.
  5. José Manuel Campa & Linda S. Goldberg, 2005. "Exchange Rate Pass-Through into Import Prices," The Review of Economics and Statistics, MIT Press, vol. 87(4), pages 679-690, November.
  6. T. W.Swan, 1960. "Economic Control In A Dependent Economy," The Economic Record, The Economic Society of Australia, vol. 36(73), pages 51-66, 03.
  7. Mario J. Crucini & Chris I. Telmer & Marios Zachariadis, 2005. "Understanding European Real Exchange Rates," American Economic Review, American Economic Association, vol. 95(3), pages 724-738, June.
  8. Caroline M. Betts & Timothy J. Kehoe, 2005. "U.S. Real Exchange Rate Fluctuations and Relative Price Fluctuations," IEPR Working Papers 05.16, Institute of Economic Policy Research (IEPR).
  9. W. E. G. Salter, 1959. "Internal And External Balance: The Role Op Price And Expenditure Effects," The Economic Record, The Economic Society of Australia, vol. 35(71), pages 226-238, 08.
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