Home About Latest Browse RSS Advanced Search

Federal Reserve Bank of Dallas
Globalization Institute Working Papers
The real exchange rate in sticky price models: does investment matter?
Enrique Martinez-Garcia
Jens Søndergaard
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.


Download Full text
Cite this item
Enrique Martinez-Garcia & Jens Søndergaard, The real exchange rate in sticky price models: does investment matter?, Federal Reserve Bank of Dallas, Globalization Institute Working Papers 17, 2008.
More from this series
Note: Published as: Martinez-Garcia, Enrique and Jens Søndergaard (2013), "Investment and Real Exchange in Sticky Price Models," Macroeconomic Dynamics17 (2): 195-234.
JEL Classification:
Subject headings:
For corrections, contact Amy Chapman ()
Fed-in-Print is the central catalog of publications within the Federal Reserve System. It is managed and hosted by the Economic Research Division, Federal Reserve Bank of St. Louis.

Privacy Legal