The real exchange rate in sticky-price models: does investment matter?

Martinez-Garcia, Enrique () and Jens Sondergaard ()
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Martinez-Garcia, Enrique: Federal Reserve Bank of Dallas
Authors registered in the RePEc Author Service: Enrique Martínez García ()

No 368, Bank of England working papers from Bank of England

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 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 earlier work that has shown how real shocks in a sticky-price model without capital can replicate the observed real exchange rate dynamics. Finally, we find that so-called persistence anomaly remains robust to several alternative capital specifications including set-ups with variable capital utilisation and investment adjustment costs. In summary, the PPP puzzle is still very much alive and well.

Keywords: Real exchange rates; capital accumulation; Taylor rules. (search for similar items in EconPapers)
JEL-codes: F11 F42 F43 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ifn and nep-mac
Date: 2009-04-27

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Related works:
Working Paper: The real exchange rate in sticky price models: does investment matter? (2008)
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Persistent link: http://EconPapers.repec.org/RePEc:boe:boeewp:0368

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