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U.S. Real Exchange Rate Fluctuations and Relative Price Fluctuations

  • Caroline M. Betts
  • Timothy J. Kehoe

This paper studies the relation between the United States’ bilateral real exchange rate and the associated bilateral relative price of nontraded goods for five of its most important trade relationships. Traditional theory attributes fluctuations in real exchange rates to changes in the relative price of nontraded goods. We find that this relation depends crucially on the choice of price series used to measure relative prices and on the choice of trade partner. The relation is stronger when we measure relative prices using producer prices rather than consumer prices. The relation is stronger the more important is the trade relationship between the United States and a trade partner. Even in cases where there is a strong relation between the real exchange rate and the relative price of nontraded goods, however, a large fraction of real exchange rate fluctuations is due to deviations from the law of one price for traded goods.

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Paper provided by Institute of Economic Policy Research (IEPR) in its series IEPR Working Papers with number 05.16.

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Length: 52 pages
Date of creation: Mar 2005
Date of revision:
Handle: RePEc:scp:wpaper:05-16
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  1. Kravis, Irving B. & Lipsey, Robert E., 1978. "Price behavior in the light of balance of payments theories," Journal of International Economics, Elsevier, vol. 8(2), pages 193-246, May.
  2. Charles Engel, 1992. "Real Exchange Rates and Relative Prices: An Empirical Investigation," NBER Working Papers 4231, National Bureau of Economic Research, Inc.
  3. Caroline M. Betts & Timothy J. Kehoe, 2008. "Real exchange rate movements and the relative price of non-traded goods," Staff Report 415, Federal Reserve Bank of Minneapolis.
  4. Maurice Obstfeld, 2003. "International Macroeconomics: Beyond the Mundell-Fleming Model," International Finance 0303006, EconWPA.
  5. Beverly J. Lapham, 1990. "A Dynamic, General Equilibrium Analysis of Deviations From the Laws of One Price," Working Papers 793, Queen's University, Department of Economics.
  6. Jean Imbs & Haroon Mumtaz & Morton O. Ravn & Helene Rey, 2002. "PPP Strikes Back: Aggregation and the Real Exchange Rate," NBER Working Papers 9372, National Bureau of Economic Research, Inc.
  7. Rogers, J.H. & Jenkins, M.A., 1993. "Haircuts or Hysteresis? Sources of Movements in Real Exchange Rates," Papers 4-93-6, Pennsylvania State - Department of Economics.
  8. Ariel Burstein & Martin Eichenbaum & Sergio Rebelo, 2002. "Why Are Rates of Inflation So Low After Large Devaluations?," NBER Working Papers 8748, National Bureau of Economic Research, Inc.
  9. Stockman, Alan C & Tesar, Linda L, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," American Economic Review, American Economic Association, vol. 85(1), pages 168-85, March.
  10. Engel, C. & Rogers, J.H., 1995. "How Wide is the Border?," Papers 4-95-16, Pennsylvania State - Department of Economics.
  11. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2002. "Can sticky price models generate volatile and persistent real exchange rates?," Staff Report 277, Federal Reserve Bank of Minneapolis.
  12. Sergio Rebelo & Carlos A. Vegh, 1995. "Real Effects of Exchange-Rate-Based Stabilization: An Analysis of Competing Theories," NBER Chapters, in: NBER Macroeconomics Annual 1995, Volume 10, pages 125-188 National Bureau of Economic Research, Inc.
  13. Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, vol. 72, pages 584.
  14. Engel, C., 1996. "Accounting for U.S. Real Exchange Rate Changes," Working Papers 96-02, University of Washington, Department of Economics.
  15. de Cordoba, Gonzalo Fernandez & Kehoe, Timothy J., 2000. "Capital flows and real exchange rate fluctuations following Spain's entry into the European Community," Journal of International Economics, Elsevier, vol. 51(1), pages 49-78, June.
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