Working Paper: NBER ID: w16081
Authors: Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
Abstract: We introduce the real exchange rate volatility curve as a useful device to understand the role of price stickiness in accounting for deviations from the Law of One Price at the sector level. In the presence of both nominal and real shocks, the theory predicts that the real exchange rate volatility curve is a U-shaped function of the degree of price stickiness. Using sector-level European real exchange rate data and frequency of price changes, we estimate the volatility curve. The results are consistent with the predominance of real effects over nominal effects. Nonparametric analysis suggests the curve is convex and negatively sloped over the majority of its range. Good-by-good variance decompositions show that the relative contribution of nominal shocks is smaller at the sector level than what previous studies have found at the aggregate level. We conjecture that this is due to significant averaging out of good-specific real microeconomic shocks in the process of aggregation.
Keywords: real exchange rate volatility; price stickiness; nominal shocks; real shocks
JEL Codes: F0; F33; F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| price stickiness (L11) | real exchange rate volatility (F31) |
| low price stickiness (D41) | minimized real exchange rate volatility (F31) |
| high price stickiness (E31) | minimized real exchange rate volatility (F31) |
| real shocks (F31) | real exchange rate volatility (F31) |
| nominal shocks (E39) | real exchange rate volatility (F31) |
| price rigidity (D41) | contribution of real shocks (E39) |
| sector-level averaging (C43) | contribution of nominal shocks (E19) |