Traded Goods Consumption Smoothing and the Random Walk Behavior of the Real Exchange Rate

36 Pages Posted: 27 Apr 2000 Last revised: 4 Jan 2002

See all articles by Kenneth Rogoff

Kenneth Rogoff

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: July 1992

Abstract

Conventional explanations of the near random walk behavior of real exchange rates rely on near random walk behavior in the underlying fundamentals (e.g.. tastes and technology). The present paper offers an alternative rationale, based on a fixed-factor neoclassical model with traded and non-traded goods. The basic idea is that with open capital markets, agents can smooth their consumption of tradeables in the face of transitory traded goods productivity shocks. Agents cannot smooth non-traded goods productivity shocks, but if these are relatively small (as is often argued to be the case) then traded goods consumption smoothing will lead to smoothing of the intra-temporal price of traded and non-traded goods. The (near) random walk implications of the model for the real exchange rate are in stark contrast to the empirical predictions of the classic Balassa-Samuelson model. The paper applies the model to the yen/dollar exchange rate over the floating rate period.

Suggested Citation

Rogoff, Kenneth S., Traded Goods Consumption Smoothing and the Random Walk Behavior of the Real Exchange Rate (July 1992). NBER Working Paper No. w4119. Available at SSRN: https://ssrn.com/abstract=226813

Kenneth S. Rogoff (Contact Author)

Harvard University - Department of Economics ( email )

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