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Real Exchange Rate Dynamics With Endogenous Distribution Costs

  • Mulraine, Millan L. B.

The importance of distribution costs in generating the deviations from the law of one price has been well documented. In this paper we show that a two-country flexible price dynamic general equilibrium model driven by exogenous innovations to technology, and with a localized distribution services sector can replicate the key dynamic features of the real exchange rate. In doing so, the paper identifies the importance of two key channels for real exchange rate dynamics. That is, we show: (i) that shocks in the real sector are important contributors to movements in the real exchange rate, and (ii) that the endogenous wedge created by distribution costs of traded goods is a significant source of fluctuation for the real exchange rate, and the overall macro-economy as a whole. The evidence presented here demonstrates that this model - without any nominal rigidities, can account for up to 89% of the relative volatility in the real exchange rate.

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File URL: http://mpra.ub.uni-muenchen.de/9/1/MPRA_paper_9.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 9.

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Date of creation: Sep 2006
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Handle: RePEc:pra:mprapa:9
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  1. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1991. "International real business cycles," Staff Report 146, Federal Reserve Bank of Minneapolis.
  2. Chari, V V & Kehoe, Patrick J & McGrattan, Ellen R, 2002. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," Review of Economic Studies, Wiley Blackwell, vol. 69(3), pages 533-63, July.
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  4. Patrick J. Kehoe & Fabrizio Perri, 2000. "International Business Cycles with Endogenous Incomplete Markets," NBER Working Papers 7870, National Bureau of Economic Research, Inc.
  5. Baxter, Marianne, 1995. "International trade and business cycles," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 35, pages 1801-1864 Elsevier.
  6. Maurice Obstfeld and Kenneth Rogoff., 2000. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," Center for International and Development Economics Research (CIDER) Working Papers C00-112, University of California at Berkeley.
  7. Greenwood, J. & Hercowitz, Z. & Krusell, P., 1998. "The Role of Investment-Specific Technological Change in the Business Cycle," RCER Working Papers 449, University of Rochester - Center for Economic Research (RCER).
  8. Lane, P, 1999. "The New Open Economy Macroeconomics: A Survey," Trinity Economics Papers 993, Trinity College Dublin, Department of Economics.
  9. Robert Kollmann, 1996. "Incomplete asset markets and the cross-country consumption correlation puzzle," ULB Institutional Repository 2013/7640, ULB -- Universite Libre de Bruxelles.
  10. Burstein, Ariel T. & Neves, Joao C. & Rebelo, Sergio, 2003. "Distribution costs and real exchange rate dynamics during exchange-rate-based stabilizations," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1189-1214, September.
  11. Carr, Jack L. & Floyd, John E., 2002. "Real and monetary shocks to the Canadian dollar: Do Canada and the United States form an optimal currency area?," The North American Journal of Economics and Finance, Elsevier, vol. 13(1), pages 21-39, May.
  12. Millan L. B. Mulraine, 2005. "Investment-Specific Technology Shocks in a Small Open Economy," Macroeconomics 0506009, EconWPA.
  13. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
  14. David Backus & Patrick J. Kehoe & Finn E. Kydland, 1992. "Dynamics of the Trade Balance and the Terms of Trade: The S-Curve," NBER Working Papers 4242, National Bureau of Economic Research, Inc.
  15. Boileau, Martin, 2002. "Trade in capital goods and investment-specific technical change," Journal of Economic Dynamics and Control, Elsevier, vol. 26(6), pages 963-984, June.
  16. Ariel Burstein & Joao C. Neves & Sergio Rebelo, 2004. "Investment Prices and Exchange Rates: Some Basic Facts," NBER Working Papers 10238, National Bureau of Economic Research, Inc.
  17. Baxter, M., 1994. "International Trade and Business Cycles," RCER Working Papers 390, University of Rochester - Center for Economic Research (RCER).
  18. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-60, June.
  19. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Closing Small Open Economy Models," NBER Working Papers 9270, National Bureau of Economic Research, Inc.
  20. Jonas D. M. Fisher, 2002. "Technology shocks matter," Working Paper Series WP-02-14, Federal Reserve Bank of Chicago.
  21. 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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  23. Alexius, Annika, 2005. "Productivity shocks and real exchange rates," Journal of Monetary Economics, Elsevier, vol. 52(3), pages 555-566, April.
  24. Betts, Caroline & Devereux, Michael B., 1996. "The exchange rate in a model of pricing-to-market," European Economic Review, Elsevier, vol. 40(3-5), pages 1007-1021, April.
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