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The Dynamic Behavior of the Real Exchange Rate in Sticky Price Models

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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 sticky price business cycle models have been unable to match the 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.

Document Type: Short Communication

DOI: https://doi.org/10.1257/aer.98.1.519

Publication date: 2008-03-01

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