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Persistent Real Exchange Rates

  • Alok Johri

    ()

    (Economics McMaster University)

  • Amartya Lahiri

This paper revisits three features of the data that are widely known: (a) there exists a high correlation between bilateral nominal and real exchange rates; (b) real exchange rate movements are highly persistent; and (c) real exchange rates are highly volatile. The paper attempts a joint, albeit partial, rationalization of these facts in an environment where prices are preset for only one quarter and there are no staggered contracts. The key innovation is that we augment a standard two-country open economy model with learning-by-doing in production at the firm level. This induces monopolistically competitive firms to endogeneize the productivity effect of their price setting behavior. Specifically, firms endogenously choose not to adjust prices by the full proportion of a positive monetary shock in order to take advantage of the productivity benefits of higher production. We show that the calibrated model can quantitatively reproduce significant fractions of the aforementioned facts.

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 281.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:281
Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Web page: http://www.EconomicDynamics.org/society.htm
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  26. C. Lanier Benkard, 2000. "Learning and Forgetting: The Dynamics of Aircraft Production," American Economic Review, American Economic Association, vol. 90(4), pages 1034-1054, September.
  27. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
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