Do sticky prices increase real exchange rate volatility at the sector level? |
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| Institution: | 1. Department of Economics, Vanderbilt University, Nashville, TN 37235 United States;2. NBER, United States;3. Graduate School of Economics, Kyoto University, Kyoto 606-8501, Japan;1. University of Amsterdam, Amsterdam School of Economics, Netherlands;2. Tilburg University, Department of Econometrics and OR, Netherlands;1. Faculty of Management Sciences, SIMAD UNIVERSITY, Mogadishu, Somalia;2. School of Management, Universiti Sains Malaysia (USM), Penang, Malaysia;1. University of Karachi, Pakistan;2. Institute of Business Administration, Karachi, Pakistan |
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| Abstract: | We introduce the real exchange rate volatility curve as a useful device to understand the relationship between price stickiness and the fluctuations in Law of One Price deviations. 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 US–European real exchange rate data and frequency of price changes, we estimate the volatility curve and find the predominance of real effects over nominal effects. 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, consistent with significant averaging out of good-specific real microeconomic shocks. |
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| Keywords: | Real exchange rates Law of one price Sticky prices Nonparametric test for monotonicity |
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