Working Paper: NBER ID: w13910
Authors: J.N. Steinsson
Abstract: Existing empirical evidence suggests that real exchange rates exhibit hump-shaped dynamics. I show that this is a robust fact across nine large, developed economies. This fact can help explain why existing sticky-price business cycle models have been unable to match the persistence of the real exchange rate. The recent literature has focused on models driven by monetary shocks. These models yield monotonic impulse responses for the real exchange rate. It is extremely difficult for models that have this feature to match the empirical persistence of the real exchange rate. I show that in response to a number of different real shocks a two-country sticky-price business cycle model yields hump-shaped dynamics for the real exchange rate. The hump-shaped dynamics generated by the model are a powerful source of endogenous persistence that allows the model to match the long half-life of the real exchange rate.
Keywords: Real Exchange Rate; Sticky Prices; Business Cycle Models
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Real shocks (E39) | Humped dynamics in the real exchange rate (F31) |
| Productivity shocks (O49) | Humped dynamics in the real exchange rate (F31) |
| Labor supply shocks (J20) | Humped dynamics in the real exchange rate (F31) |
| Government spending shocks (E62) | Humped dynamics in the real exchange rate (F31) |
| Cost-push shocks (E31) | Humped dynamics in the real exchange rate (F31) |
| Real shocks (E39) | Greater volatility than monetary shocks (E39) |