Working Paper: NBER ID: w1066
Authors: Joshua Aizenman
Abstract: The volatility of the exchange rate under floating rates can be interpreted in terms of approaches that allow for short term price rigidity as well as in terms of models that consider the magnification effect of new information. This paper combines the two approaches into a unified framework,where the degree to which prices are rigid is determined endogenously. It is shown that the variance of percentage deviations from ppp has an upper bound,and that the relationship between the variance of deviations from ppp and the aggregate variability is not monotonic. Allowing for a short-run Phillips curve with optimal indexation, it is also demonstrated that a higher price flexibility will reduce deviations from ppp and output volatility.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| price flexibility (D41) | deviations from PPP (F31) |
| deviations from PPP (F31) | output volatility (E23) |
| deviations from PPP (F31) | variance of deviations from PPP (F31) |
| price flexibility (D41) | output volatility (E23) |
| transaction costs (D23) | deviations from PPP (F31) |