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Why Is the Business-Cycle Behavior of Fundamentals Alike Across Exchange-Rate Regimes?

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  • Luca Dedola

    (Research Department, Bank of Italy)

  • Sylvain Leduc

    (Federal Reserve Bank of Philadelphia)

Abstract

Since the adoption of flexible exchange rates, real exchange rates have been much more volatile than they were under Bretton Woods. However, the volatilities of most other macroeconomic variables have remained approximately unchanged. This poses a puzzle for standard international business cycle models. This paper develops a two-country, two-sector model with nominal rigidities featuring deviations from the law of one price due to firms setting prices in buyersÂ’ currencies. By partially insulating goods markets across countries and thus mitigating the international expenditure-switching effect, this pricing behavior is found to considerably dampen the responses of quantities to shocks hitting the economies therefore helping to account for the puzzle.

Suggested Citation

  • Luca Dedola & Sylvain Leduc, 2001. "Why Is the Business-Cycle Behavior of Fundamentals Alike Across Exchange-Rate Regimes?," Working Papers 53, Oesterreichische Nationalbank (Austrian Central Bank).
    • Handle: RePEc:onb:oenbwp:53
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    Cited by:

    1. Kollmann, Robert, 2002. "Monetary policy rules in the open economy: effects on welfare and business cycles," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 989-1015, July.
    2. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2005. "DSGE Models of High Exchange-Rate Volatility and Low Pass-Through," Economics Working Papers ECO2005/23, European University Institute.
    3. Theptida Sopraseuth, 2003. "Exchange Rate Regimes and International Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(2), pages 338-361, April.
    4. Daniel Stavárek, 2013. "Cyclical Relationship Between Exchange Rates and Macro-Fundamentals in Central And Eastern Europe," Economic Research-Ekonomska Istraživanja, Taylor & Francis Journals, vol. 26(2), pages 83-98, January.
    5. Reichlin, Lucrezia & Forni, Mario & Cristadoro, Riccardo & Veronese, Giovanni, 2001. "A Core Inflation Index for the Euro Area," CEPR Discussion Papers 3097, C.E.P.R. Discussion Papers.
    6. Reinhart, Carmen, 2002. "A Modern History of Exchange Rate Arrangements: The Country Histories, 1946-2001," MPRA Paper 13191, University Library of Munich, Germany.
    7. Kollmann, Robert, 2005. "Macroeconomic effects of nominal exchange rate regimes: new insights into the role of price dynamics," Journal of International Money and Finance, Elsevier, vol. 24(2), pages 275-292, March.
    8. Marco Riguzzi & Philipp Wegmueller, 2017. "Economic Openness and Fiscal Multipliers," International Economic Journal, Taylor & Francis Journals, vol. 31(1), pages 1-35, January.
    9. Carmen M. Reinhart & Kenneth S. Rogoff, 2004. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 119(1), pages 1-48.
    10. Kollmann, Robert, 2002. "Monetary Policy Rules in a Two-Country World," MPRA Paper 70347, University Library of Munich, Germany.
    11. Kollmann, Robert, 2003. "Monetary Policy Rules in an Interdependent World," CEPR Discussion Papers 4012, C.E.P.R. Discussion Papers.
    12. Alessandro Cantelmo & Pietro Cova & Alessandro Notarpietro & Massimiliano Pisani, 2022. "Make-up strategies and exchange rate pass-through in a low-interest-rate environment," Temi di discussione (Economic working papers) 1398, Bank of Italy, Economic Research and International Relations Area.
    13. Riccardo Cristadoro & Andrea Gerali & Stefano Neri & Massimiliano Pisani, 2006. "Nominal Rigidities in an Estimated Two Country," Computing in Economics and Finance 2006 162, Society for Computational Economics.
    14. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2008. "High exchange-rate volatility and low pass-through," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1113-1128, September.
    15. Stavárek Daniel & Miglietti Cynthia, 2015. "Effective Exchange Rates in Central and Eastern European Countries: Cyclicality and Relationship with Macroeconomic Fundamentals," Review of Economic Perspectives, Sciendo, vol. 15(2), pages 157-177, June.
    16. Philipp Wegmueller, 2014. "Floating or fixed exchange rates: The role of government size," Diskussionsschriften dp1404, Universitaet Bern, Departement Volkswirtschaft.
    17. Lorenzo Burlon & Alessandro Notarpietro & Massimiliano Pisani, 2018. "Exchange rate pass-through into euro area inflation. An estimated structural model," Temi di discussione (Economic working papers) 1192, Bank of Italy, Economic Research and International Relations Area.
    18. Calderón, César & Kubota, Megumi, 2018. "Does higher openness cause more real exchange rate volatility?," Journal of International Economics, Elsevier, vol. 110(C), pages 176-204.
    19. Riccardo Cristadoro & Andrea Gerali & Stefano Neri & Massimiliano Pisani, 2008. "Real exchange rate volatility and disconnect: an empirical investigation," Temi di discussione (Economic working papers) 660, Bank of Italy, Economic Research and International Relations Area.

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    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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