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Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?

  • V.V. Chari
  • Patrick J. Kehoe
  • Ellen R. McGrattan

The central puzzle in international business cycles is that real exchange rates are volatile and persistent. The most popular story for real exchange rate fluctuations is that they are generated by monetary shocks interacting with sticky goods prices. We quantify this story and find that it can account for some of the observed properties of real exchange rates. When prices are held fixed for at least one year, risk aversion is high and preferences are separable in leisure, the model generates real exchange rates that are as volatile as in the data. The model also generates real exchange rates that are persistent, but less so than in the data. If monetary shocks are correlated across countries, then the comovements in aggregates across countries are broadly consistent with those in the data. Making asset markets incomplete or introducing sticky wages does not measurably change the results.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7869.

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Date of creation: Sep 2000
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Publication status: published as Chari, V. V., Patrick J. Kehoe and Ellen R. McGrattan. "Can Sticky Price Models Generate Volatile And Persistent Real Exchange Rates?," Review of Economic Studies, 2002, v69(3,240,Jul), 533-563.
Handle: RePEc:nbr:nberwo:7869
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