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Accounting for Real Exchange Rates using Micro-Data

  • Anthony Landry

    (Federal Reserve Bank of Dallas)

  • Mario Crucini

    (Vanderbilt University)

There are two stark views of the forces driving aggregate real exchange rates in the short-run. One view is that all of the variance is accounted for by non-traded items in the CPI basket (the classical dichotomy view), the other, due to Engel (1999), claims the opposite, with all of the variance attributable to traded items. We formulate a novel variance decomposition technique to deal with the large covariance of LOP deviations across goods. We find that the facts lie almost exactly between these two views. While the contribution to real exchange rate variability differs across goods, the dichotomous classification into traded and non-traded categories is not a good way to characterize those difference. We argue that the view that all retail goods are composites of traded and non-traded inputs is preferrable as it `convexifies' the two polar views and brings the data much closer to recent theoretical approaches emphasizing a distribution margin or trade in intermediate inputs.

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Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 1100.

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Date of creation: 2010
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Handle: RePEc:red:sed010:1100
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. Burstein, Ariel Tomas & Neves, Joao C & Rebelo, Sérgio, 2001. "Distribution Costs and Real Exchange Rate Dynamics During Exchange-Rate-Based Stabilization," CEPR Discussion Papers 2944, C.E.P.R. Discussion Papers.
  2. Engel, C. & Rogers, J.H., 1995. "How Wide is the Border?," Papers 4-95-16, Pennsylvania State - Department of Economics.
  3. Caroline M. Betts & Timothy J. Kehoe, 2004. "U.S. real exchange rate fluctuations and relative price fluctuations," Staff Report 334, Federal Reserve Bank of Minneapolis.
  4. Burstein, Ariel Tomas & Eichenbaum, Martin & Rebelo, Sérgio, 2004. "Large Devaluations and the Real Exchange Rate," CEPR Discussion Papers 4810, C.E.P.R. Discussion Papers.
  5. Mario Crucini & Chris Telmer & Marios Zachariadis, . "Understanding European Real Exchange Rates," GSIA Working Papers 227, Carnegie Mellon University, Tepper School of Business.
  6. T. W.Swan, 1960. "Economic Control In A Dependent Economy," The Economic Record, The Economic Society of Australia, vol. 36(73), pages 51-66, 03.
  7. David Parsley & Helen Popper, 2010. "Understanding Real Exchange Rate Movements With Trade In Intermediate Products," Pacific Economic Review, Wiley Blackwell, vol. 15(2), pages 171-188, 05.
  8. W. E. G. Salter, 1959. "Internal And External Balance: The Role Op Price And Expenditure Effects," The Economic Record, The Economic Society of Australia, vol. 35(71), pages 226-238, 08.
  9. Campa, José Manuel & Goldberg, Linda S., 2004. "Exchange Rate Pass-Through into Import Prices," CEPR Discussion Papers 4391, C.E.P.R. Discussion Papers.
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