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The Macroeconomics of Exchange-rate and Price-level Interactions: Empirical Evidence for West Germany

  • Alberto Giovannini
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    This paper studies the evidence on the conditional covariances between the German wholesale price level and the Deutsche mark exchange rate in the short run and in the long run. I rely both on an unrestricted time-series model, and on a structural Mussa-Dornbusch model. The results from unrestricted estimates indicate that the volatility of change. in the nominal exchange rate much exceed the volatility of the inflation rate both in the short run and in the long run. This implies a very high correlation between changes in the nominal and real exchange rate, and a correlation between the inflation rate and changes in the exchange rate that never exceeds .4--with 959 probability. The results from the structural estimates and sensitivity analysis indicate that perfect price flexibility is strongly rejected, and chat the model tends to make sticky prices play a crucial role in explaining the evidence. Since the overidentifying restrictions implied by the structural model are rejected, I conclude that we still do not have a fully satisfactory explanation of observed extreme sluggishness of aggregate price levels.

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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2544.

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    Date of creation: Mar 1988
    Date of revision:
    Handle: RePEc:nbr:nberwo:2544
    Note: ITI IFM
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    1. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
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    9. Nelson, Charles R. & Plosser, Charles I., 1982. "Trends and random walks in macroeconmic time series : Some evidence and implications," Journal of Monetary Economics, Elsevier, vol. 10(2), pages 139-162.
    10. Huizinga, John, 1987. "An empirical investigation of the long-run behavior of real exchange rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 27(1), pages 149-214, January.
    11. Parkin, Michael, 1986. "The Output-Inflation Trade-off When Prices Are Costly to Change," Journal of Political Economy, University of Chicago Press, vol. 94(1), pages 200-224, February.
    12. Samuelson, Paul A, 1976. "Is Real-World Price a Tale Told by the Idiot of Chance?," The Review of Economics and Statistics, MIT Press, vol. 58(1), pages 120-23, February.
    13. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
    14. Wing T. Woo, 1984. "Exchange Rates and the Prices of Nonfood, Nonfuel Products," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(2), pages 511-536.
    15. Nelson, Charles R & Kang, Heejoon, 1979. "Spurious Periodicity in Inappropriately Detrended Time Series," The Warwick Economics Research Paper Series (TWERPS) 161, University of Warwick, Department of Economics.
    16. Obstfeld, Maurice & Stockman, Alan C., 1985. "Exchange-rate dynamics," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 18, pages 917-977 Elsevier.
    17. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
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