Exchange Rate Dynamics with Sticky Prices: the Deutsch Mark, 1974-1982

Abstract

This paper estimates simultaneously dynamic equations for the Deutsche Mark/Dollar exchange rate and the German wholesale price index, which emerge from a model in which German prices are sticky. This stickiness is due to price adjustment costs which take the form posited by Rotemberg(1982).The main results of the empirical analysis are two: First, the version of the model where prices are perfectly flexible is rejected. Second, real exchange rate variability is mostly accounted for by nominal exchange rate variability. We find substantial overshooting of the exchange rate to monetary innovations like those which appear to be typical in Germany.