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Author:Hevia, Constantino 

Report
Real Exchange Rates and Primary Commodity Prices
In this paper, we show that there is substantial comovement between prices of primary commodities such as oil, aluminum, maize, or copper and real exchange rates between developed economies such as Germany, Japan, and the United Kingdom against the US dollar. We therefore explicitly consider the production of commodities in a two-country model of trade with productivity shocks and shocks to the supplies of commodities. We calibrate the model so as to reproduce the volatility and persistence of primary commodity prices and show that it delivers equilibrium real exchange rates that are as volatile and persistent as in the data. The model rationalizes an empirical strategy to identify the fraction of the variance of real exchange rates that can be accounted for by the underlying shocks, even if those are not observable. We use this strategy to argue that shocks that move primary commodity prices account for a large fraction of the volatility of real exchange rates in the data. Our analysis implies that existing models used to analyze real exchange rates between large economies that mostly focus on trade between differentiated final goods could benefit, in terms of matching the behavior of real exchange rates, by also considering trade in primary commodities.
AUTHORS: Hevia, Constantino; Nicolini, Juan Pablo; Ayres, Joao Luiz
DATE: 2019-05-09

Working Paper
Monetary Policy and Dutch Disease: The Case of Price and Wage Rigidity
We study a model of a small open economy that specializes in the production of commodities and that exhibits frictions in the setting of both prices and wages. We study the optimal response of monetary and exchange rate policy following a positive (negative) shock to the price of the exportable that generates an appreciation (depreciation) of the local currency. According to the calibrated version of the model, deviations from full price stability can generate welfare gains that are equivalent to almost 0.5% of lifetime consumption, as long as there is a significant degree of rigidity in nominal wages. On the other hand, if the rigidity is concentrated in prices, the welfare gains can be at most 0.1% of lifetime consumption. We also show that a rule - formally defined in the paper - that resembles a "dirty floating" regime can approximate the optimal policy remarkably well.
AUTHORS: Hevia, Constantino; Nicolini, Juan Pablo
DATE: 2015-06-08

Working Paper
Real Exchange Rates and Primary Commodity Prices
In this paper, we show that a substantial fraction of the volatility of real exchange rates between developed economies such as Germany, Japan, and the United Kingdom against the US dollar can be accounted for by shocks that affect the prices of primary commodities such as oil, aluminum, maize, or copper. Our analysis implies that existing models used to analyze real exchange rates between large economies that mostly focus on trade between differentiated ?nal goods could benefit, in terms of matching the behavior of real exchange rates, by also considering trade in primary commodities.
AUTHORS: Hevia, Constantino; Nicolini, Juan Pablo; Ayres, Joao Luiz
DATE: 2017-11-13

Working Paper
Monitoring Money for Price Stability
In this paper, we use a simple model of money demand to characterize the behavior of monetary aggregates in the United States from 1960 to 2016. We argue that the demand for the currency component of the monetary base has been remarkably stable during this period. We use the model to make projections of the nominal quantity of cash in circulation under alternative future paths for the federal funds rate. Our calculations suggest that if the federal funds rate is lifted up as suggested by the survey of economic projections made by the members of the Federal Open Market Committee (FOMC), the fall in total currency demanded in the next two years ranges between 50 and 200 billion. Our discussion suggests that specific measures by the Federal Reserve to absorb that cash could be worth considering to make the future path of the price level consistent with the price stability mandate.
AUTHORS: Nicolini, Juan Pablo; Hevia, Constantino
DATE: 2017-11-14

Working Paper
Optimal devaluations
We analyze optimal policy in a simple small open economy model with price setting frictions. In particular, we study the optimal response of the nominal exchange rate following a terms of trade shock. We depart from the New Keynesian literature in that we explicitly model interna-tionally traded commodities as intermediate inputs in the production of local final goods and assume that the small open economy takes this price as given. This modification not only is in line with the long-standing tradition of small open economy models, but also changes the optimal movements in the exchange rate. In contrast with the recent small open economy New Keynesian literature, our model is able to reproduce the comovement between the nominal exchange rate and the price of exports, as it has been documented in the commodity currencies literature. Although we show there are preferences for which price stability is optimal even without flexible fiscal instruments, our model suggests that more attention should be given to the coordination between monetary and fiscal policy (taxes) in small open economies that are heavily dependent on exports of commodities. The model we propose is a useful framework in which to study fear of floating.
AUTHORS: Nicolini, Juan Pablo; Hevia, Constantino
DATE: 2013

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