The Real Exchange Rate in Sticky Price Models: Does Investment Matter?

Posted: 14 Jul 2021

See all articles by Enrique Martínez-García

Enrique Martínez-García

Federal Reserve Bank of Dallas - Research Department

Jens Sondergaard

affiliation not provided to SSRN

Date Written: 2008

Abstract

This paper re-examines the ability of sticky-price models to generate volatile and persistent real exchange rates. We use a DSGE framework with pricing-to-market akin to those in Chari, et al. (2002) and Steinsson (2008) to illustrate the link between real exchange rate dynamics and what the model assumes about physical capital. We show that adding capital accumulation to the model facilitates consumption smoothing and significantly impedes the model's ability to generate volatile real exchange rates. Our analysis, therefore, caveats the results in Steinsson (2008) who shows how real shocks in a sticky-price model without capital can replicate the observed real exchange rate dynamics. Finally, we find that the CKM (2002) persistence anomaly remains robust to several alternative capital specifications including set-ups with variable capital utilization and investment adjustment costs (see, e.g., Christiano, et al., 2005). In summary, the PPP puzzle is still very much alive and well.

JEL Classification: F31, F37, F41

Suggested Citation

Martinez-Garcia, Enrique and Sondergaard, Jens, The Real Exchange Rate in Sticky Price Models: Does Investment Matter? (2008). Available at SSRN: https://ssrn.com/abstract=3885383

Enrique Martinez-Garcia (Contact Author)

Federal Reserve Bank of Dallas - Research Department ( email )

2200 North Pearl Street
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Dallas, TX 75265-5906
United States
214-922-5262 (Phone)

HOME PAGE: http://sites.google.com/view/emgeconomics

Jens Sondergaard

affiliation not provided to SSRN

No Address Available

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