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Understanding Real Exchange Rate Movements with Trade in Intermediate Products

  • Parsley, David
  • Popper, Helen

We suggest it may be "too easy" to attribute real exchange rate movements to law of one price deviations. We show that it is immaterial whether one uses seemingly traded goods, nontraded goods, or even just a single, unimportant consumer good, say beer. The ease of attributing the variation to any such deviations is explained using a model with intermediate goods trade. In the model, the stage of production determines the traded/nontraded distinction. We find empirical substantiation for the model: law of one price deviations lose explanatory power; and - defined appropriately in terms of intermediate goods - relative prices matter.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 21117.

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Date of creation: Feb 2009
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Handle: RePEc:pra:mprapa:21117
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  13. Enrique G. Mendoza, 2006. "Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies," IMF Working Papers 06/88, International Monetary Fund.
  14. Michael B. Devereux & Charles Engel & Cedric Tille, 1999. "Exchange Rate Pass-Through and the Welfare Effects of the Euro," NBER Working Papers 7382, National Bureau of Economic Research, Inc.
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  16. Obstfeld, Maurice, 2001. "International Macroeconomics: Beyond the Mundell-Fleming Model," Center for International and Development Economics Research, Working Paper Series qt6796n8s0, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
  17. David C. Parsley & Shang-Jin Wei, 2000. "Explaining the Border Effect: The Role of Exchange Rate Variability, Shipping Costs, and Geography," NBER Working Papers 7836, National Bureau of Economic Research, Inc.
  18. Sanyal, Kalyan K & Jones, Ronald W, 1982. "The Theory of Trade in Middle Products," American Economic Review, American Economic Association, vol. 72(1), pages 16-31, March.
  19. Ganguly, Srideep & Breuer, Janice Boucher, 2010. "Nominal exchange rate volatility, relative price volatility, and the real exchange rate," Journal of International Money and Finance, Elsevier, vol. 29(5), pages 840-856, September.
  20. Ronald MacDonald & Luca Antonio Ricci, 2005. "The Real Exchange Rate And The Balassa-Samuelson Effect: The Role Of The Distribution Sector," Pacific Economic Review, Wiley Blackwell, vol. 10(1), pages 29-48, 02.
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