Understanding Real Exchange Rate Movements with Trade in Intermediate Products

26 Pages Posted: 12 Aug 2006 Last revised: 25 Nov 2012

David C. Parsley

Vanderbilt University – Finance

Helen Popper

Santa Clara University - Leavey School of Business - Economics Department

Multiple version iconThere are 2 versions of this paper

Date Written: February 9, 2009

Abstract

We suggest it may be "too easy" to attribute real exchange rate movements to law of one price deviations. We show that it is immaterial whether one uses seemingly traded goods, nontraded goods, or even just a single, unimportant consumer good, say beer. The ease of attributing the variation to any such deviations is explained using a model with intermediate goods trade. In the model, the stage of production determines the traded/nontraded distinction. We find empirical substantiation for the model: law of one price deviations lose explanatory power; and - defined appropriately in terms of intermediate goods - relative prices matter.

Keywords: Real Exchange Rates, PPP, MSE decomposition

JEL Classification: F3, F4

Suggested Citation

Parsley, David C. and Popper, Helen, Understanding Real Exchange Rate Movements with Trade in Intermediate Products (February 9, 2009). Available at SSRN: https://ssrn.com/abstract=904323 or http://dx.doi.org/10.2139/ssrn.904323

David C. Parsley (Contact Author)

Vanderbilt University – Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States
615-322-0649 (Phone)
615-343-7177 (Fax)

Helen Popper

Santa Clara University - Leavey School of Business - Economics Department ( email )

500 El Camino Real
Santa Clara, CA California 95053
United States
(408) 554-6952 (Phone)
(408) 554-2331 (Fax)

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