Mussa redux and conditional PPP |
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Institution: | 1. Department of Economics, Stern School of Business, New York University, 44 West Fourth Street, New York, NY 10012, USA;2. National Bureau of Economic Research, 1050 Massachusetts Ave, Cambridge, MA 02138, USA |
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Abstract: | The extreme persistence of real exchange rates found commonly in post-Bretton Woods data does not hold in the preceding fixed exchange rate period, when the half-life was roughly half as large in our sample. This finding supports sticky price models as an explanation for real exchange rate behavior, extending the classic argument of Mussa (1986) from a focus on short-run volatility to long-run dynamics. Two thirds of the rise in real exchange rate variance observed across exchange rate regimes is attributable to greater persistence of responses to shocks, including greater price stickiness, rather than to greater variance of shocks themselves. |
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Keywords: | Real exchange rate Persistence Exchange rate regimes Sticky price models |
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