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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. Still, exchange rate depreciation worsens the terms of trade -- in accord with the evidence stressed by Obstfeld and Rogoff [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 Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 845.

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Date of creation: 2005
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Handle: RePEc:fip:fedgif:845
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  1. Anderton, Robert, 2003. "Extra-euro area manufacturing import prices and exchange rate pass-through," Working Paper Series 0219, European Central Bank.
  2. Smets, Frank & Wouters, Raf, 2002. "An estimated stochastic dynamic general equilibrium model of the euro area," Working Paper Series 0171, European Central Bank.
  3. 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.
  4. Charles Engel, 2006. "Equivalence Results for Optimal Pass-Through, Optimal Indexing to Exchange Rates, and Optimal Choice of Currency for Export Pricing," Journal of the European Economic Association, MIT Press, vol. 4(6), pages 1249-1260, December.
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  7. Sylvain Leduc, 2000. "Why Is the Business Cycle Behavior of Fundamentals Alike Across Exchange Rate Regimes?," Econometric Society World Congress 2000 Contributed Papers 1843, Econometric Society.
  8. Taylor, John B., 2000. "Low inflation, pass-through, and the pricing power of firms," European Economic Review, Elsevier, vol. 44(7), pages 1389-1408, June.
  9. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," NBER Working Papers 7869, National Bureau of Economic Research, Inc.
  10. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2008. "International Risk Sharing and the Transmission of Productivity Shocks," Review of Economic Studies, Oxford University Press, vol. 75(2), pages 443-473.
  11. Giancarlo Corsetti & Luca Dedola, 2002. "Macroeconomics of international price discrimination," Temi di discussione (Economic working papers) 461, Bank of Italy, Economic Research and International Relations Area.
  12. 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.
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  17. David Backus & Patrick J. Kehoe & Finn E. Kydland, 1993. "International Business Cycles: Theory and Evidence," NBER Working Papers 4493, National Bureau of Economic Research, Inc.
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  19. 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).
  20. Maurice Obstfeld & Kenneth Rogoff, 2000. "New Directions for Stochastic Open Economy Models," International Finance 0004002, EconWPA.
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  26. Frankel, Jeffrey A. & Wei, Shang-jin & Parsley, David, 2012. "Slow Pass-through Around the World: A New Import for Developing Countries?," Scholarly Articles 10494212, Harvard Kennedy School of Government.
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  28. 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.).
  29. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters, in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412 National Bureau of Economic Research, Inc.
  30. Kim, Jinill, 2000. "Constructing and estimating a realistic optimizing model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 45(2), pages 329-359, April.
  31. John Whalley, 1984. "Trade Liberalization among Major World Trading Areas," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262231204, June.
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  34. Joseph E. Gagnon & Jane Ihrig, 2001. "Monetary policy and exchange rate pass-through," International Finance Discussion Papers 704, Board of Governors of the Federal Reserve System (U.S.).
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