Working Paper: CEPR ID: DP2356
Authors: Harald Hau
Abstract: This paper relates the volatility of the (trade-weighted) effective real exchange rate to the degree of trade openness of an economy. The theoretical part presents an intertemporal monetary model with nominal labour (factor) market rigidities. Both monetary and aggregate supply shocks are shown to imply a (non-linear) inverse relationship between the import share of an economy and the volatility of its real exchange rate. Empirical evidence on a cross-section of 54 countries confirms this relationship: Difference in trade openness explain a large part of the cross-country variation in the volatility of the effective real exchange rate.
Keywords: real effective exchange rates; volatility; nontradeables
JEL Codes: F30; F40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary and aggregate supply shocks (E19) | nonlinear inverse relationship between import share and volatility of real exchange rate (F31) |
| higher share of nontradeables (F19) | larger nominal exchange rate changes (F31) |
| higher trade integration (F15) | diminished impact of monetary and real shocks on real exchange rate (F31) |
| increased trade openness (F19) | reduced real exchange rate volatility (F31) |
| trade openness (F43) | variation in real exchange rate volatility (F31) |