Real Exchange Rate Movements and the Relative Price of Non-Traded Goods

54 Pages Posted: 17 Oct 2017

See all articles by Caroline Betts

Caroline Betts

University of Southern California - Department of Economics

Timothy J. Kehoe

University of Minnesota - Twin Cities - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: October 10, 2017

Abstract

We show that the quarterly bilateral real exchange rate for 1275 country pairs over 1980–2015 is positively correlated with the relative price of non-traded to traded goods, but that movements in the relative price measure are smaller than those in the real exchange rate. Variance decompositions indicate that about one-third of deviations in levels of the real exchange rate, and about one quarter of yearly and four-yearly changes are accounted for by fluctuations in the relative price measure. The relation between the two variables is stronger when there is an intense trade relationship between two countries and when the variance of the real exchange rate between them is small. The relation is not systematically altered by the presence of rich country/poor country bilateral pairs or by high inflation/low inflation country pairs, is invariant over subsamples of the time period, and does not change when annual data including China is used. We identify an anomaly: The portion of real exchange rate variance accounted for by the relative price of non-traded goods for U.S./EU and NAFTA/EU bilateral trade partners is unusually small.

Keywords: Real Exchange Rates, Relative Prices, Non-Traded Goods, Trade Relationships

JEL Classification: F10, F14, F30, F41

Suggested Citation

Betts, Caroline M. and Kehoe, Timothy J., Real Exchange Rate Movements and the Relative Price of Non-Traded Goods (October 10, 2017). USC-INET Research Paper No. 17-31, Available at SSRN: https://ssrn.com/abstract=3052021 or http://dx.doi.org/10.2139/ssrn.3052021

Caroline M. Betts (Contact Author)

University of Southern California - Department of Economics ( email )

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Timothy J. Kehoe

University of Minnesota - Twin Cities - Department of Economics ( email )

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