Working Paper: NBER ID: w11691
Authors: Enrique G. Mendoza
Abstract: The dominant view in the empirical literature on exchange rates is that the high variability of real exchange rates is due to movements in exchange-rate-adjusted prices of tradable goods. This paper shows that this dominant view does not hold in Mexican data for the periods in which the country had managed exchange rate regimes. Variance analysis of a 30-year sample of monthly data shows that movements in the price of nontradables relative to tradables account for up to 70 percent of the variability of the real exchange rate during these periods. The paper proposes a model in which this stylized fact, and the Sudden Stops that accompanied the collapse of Mexico's managed exchange rates, could result from an endogenous amplification mechanism operating via nontradables prices in economies with dollarized liabilities and credit constraints. The key feature of this mechanism is Irving Fisher's debt-deflation process. Numerical evaluation suggests that the Fisherian deflation effects on consumption, the current account, and relative prices dwarf those induced by the standard balance sheet effect typical of the Sudden Stops literature.
Keywords: Real Exchange Rate; Nontradables; Sudden Stops; Liability Dollarization
JEL Codes: F30; F41; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fluctuations in the price of nontradables (F16) | variability of the real exchange rate (F31) |
| liability dollarization (F65) | variability of the real exchange rate (F31) |
| credit constraints (E51) | variability of the real exchange rate (F31) |
| sudden policy-induced changes in relative prices (P22) | variability of the real exchange rate (F31) |
| Fisherian debt-deflation process (E43) | consumption fluctuations (E20) |
| Fisherian debt-deflation process (E43) | prices fluctuations (E30) |