Changes in Real Exchange Rates
An NBER-Universities Research Conference on "Changes in Real Exchange Rates: Causes and Consequences" took place in Cambridge on December 8 and 9. Alan C. Stockman, NBER and University of Rochester, organized this two-day program:
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Using a panel of over 5,000 local currency prices of retail goods and services sold in the capital cities of Europe in 1975, 1985, and 1990, Crucini, Telmer, and Zachariadis characterize the behavior of average relative prices -- "real exchange rates" -- as well as the dispersion around those averages. They find that the averages are surprisingly close to what purchasing power parity (PPP) would suggest. In other words, the averages of foreign-to-domestic price ratios (across goods for a particular pair of countries) provide relatively accurate predictions of most nominal cross-rates. However, variation around the averages is large and related to economically meaningful characteristics of goods, such as measures of international tradeability, the importance of nontraded inputs in production, and the competitive structure of the markets in which the goods are sold. Using data on product brands, the authors also find that product heterogeneity is at least as important as geography in explaining relative price dispersion.
Empirical floating exchange rates tend to exhibit substantial volatility and persistent misalignments. Kumakura discusses how the instability and the consequent uncertainty of floating rates can affect the relationship between exchange rates and import/export prices. He suggests the possibility that currency instability influences the dynamic relationship between exchange rates and prices in subtle but important ways. His models also can explain many empirical puzzles about traded goods prices.
Cook and Devereux explore the macroeconomic effects of capital market panics in a small open economy. Their model arises out of the sudden and dramatic capital outflows from East Asian economies in 1997-8, which led to sharp exchange rate depreciations, and were followed by a collapse in the real economy and a large reversal in the position of the current account. The authors' interpretation of this event follows the literature on "financial fragility," which points to the problems of the maturity mismatch between short-term borrowing and long-term investment projects giving rise to the risk of capital market panics. However, Cook and Devereux go beyond this literature by constructing a complete macro model that can reproduce many of the quantitative features of the Asian crisis.
Empirical studies comparing fixed and flexible exchange rate regimes document that countries moving from pegged to floating systems experience a systematic and dramatic rise in the variability of the real exchange rate. However, there is very little evidence that the behavior of other macroeconomic variables varies systematically with the regime. Duarte seeks to resolve this puzzle. She examines the effects of the exchange rate regime in a dynamic general equilibrium model with incomplete asset markets and nominal goods prices set in the buyers' currency. The model predicts a sharp increase in the volatility of the real exchange rate when moving from pegged to floating rates, while this pattern is not observed for other variables. The model also predicts a higher co-movement of variables across countries under fixed rates than under flexible rates, a prediction that accords with recent empirical studies.
Benigno analyzes the effects of alternative monetary rules on real exchange rate persistence. Using a two-country stochastic dynamic general equilibrium model, with nominal price stickiness and local currency pricing, he shows how the persistence of PPP deviations can be related to a monetary theory of these deviations. There is no proportionality found between the time during which prices remain sticky and the persistence of the response of the real exchange rate. That is, high nominal price rigidity is not sufficient to generate any persistence following a monetary shock.
Klein, Schuh, and Triest demonstrate a statistically significant and economically relevant effect of the real exchange rate on job creation and job destruction in U.S. manufacturing industries from 1973 to 1993. The responsiveness of these gross job flows to the real exchange rate reflects pervasive heterogeneity with respect to international conditions across firms, even within narrowly defined industries. The authors show that the responsiveness of job flows to movements in the real exchange rate varies with the industry's openness to international trade. They also show an asymmetry in the responsiveness of job flows to the real exchange rate; appreciations play a significant role in job destruction, but job flows do not respond significantly to dollar depreciations.
Fluctuations in the terms-of-trade -- the price of a country's exports relative to the price of its imports -- are a source of perennial concern to policymakers in developing and industrialized nations alike. Baxter and Kouparitsas decompose a country's terms of trade volatility into a "goods price effect," which stems from differences in the composition of import baskets and export baskets, and a "country price effect," which results from cross-country differences in the price of a particular class of goods. They then ask whether the decomposition depends on country characteristics, for example, developed versus less-developed, or exporter of manufactured goods versus exporter of fuels or other commodities.
Parsley and Wei exploit a three-dimensional panel dataset of prices on 27 traded goods over 88 quarters and across 96 cities in the United States and Japan. They show that a simple average of goods-level real exchange rates tracks the nominal exchange rate well, suggesting strong evidence of sticky prices. Focusing on dispersion in prices between city-pairs, the authors find that crossing the U.S.-Japan border is equivalent to adding as much as 43,000 trillion miles to the cross-country volatility of relative prices. The authors find that distance, unit-shipping costs, and exchange rate variability, collectively, explain a substantial portion of the observed international market segmentation. Relative wage variability, on the other hand, has little independent impact on segmentation.