Can sticky price models generate volatile and persistent real exchange rates?

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The central puzzle in international business cycles is that fluctuations in real exchange rates are volatile and persistent. We quantify the popular story for real exchange rate fluctuations: they are generated by monetary shocks interacting with sticky goods prices. If prices are held fixed for at least one year, risk aversion is high, and preferences are separable in leisure, then real exchange rates generated by the model are as volatile as in the data and quite persistent, but less so than in the data. The main discrepancy between the model and the data, the consumption-real exchange rate anomaly, is that the model generates a high correlation between real exchange rates and the ratio of consumption across countries, while the data show no clear pattern between these variables.

Original languageEnglish (US)
Pages (from-to)533-563
Number of pages31
JournalReview of Economic Studies
Issue number3
StatePublished - Jul 2002

Bibliographical note

Funding Information:
Acknowledgements. Chari, Kehoe, and McGrattan thank the National Science Foundation for support. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.


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