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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.

Suggested Citation

  • Mulraine, Millan L. B., 2006. "Real Exchange Rate Dynamics With Endogenous Distribution Costs," MPRA Paper 9, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:9

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    References listed on IDEAS

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    Cited by:

    1. Christoph Thoenissen, 2006. "Real Exchange Rate Volatility and Asset Market Structure," CDMA Working Paper Series 200609, Centre for Dynamic Macroeconomic Analysis, revised 15 Oct 2006.

    More about this item


    Distribution costs; Real exchange rate dynamics; Law of one price;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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