DSGE Models of High Exchange-Rate Volatility and Low Pass-Through

Giancarlo Corsetti, Luca Dedola () and Sylvain Leduc

No 5377, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper develops a quantitative, dynamic, open-economy model which endogenously generates high exchange rate volatility, whereas a low degree of exchange rate pass-through (ERPT) stems from both nominal rigidities (in the form of local currency pricing) and price discrimination. We model real exchange rate volatility in response to real shocks by reconsidering and extending two approaches suggested by the quantitative literature (one by Backus Kehoe and Kydland [1995], the other by Chari, Kehoe and McGrattan [2003]), within a common framework with incomplete markets and segmented domestic economies. We show that, in our framework, both approaches are successful in generating volatility without any need for nominal shocks, and without suffering from shortcomings such as a fall in import volatility. Our model accounts for a variable degree of ERPT over different horizons. In the short run, we find that a very small amount of nominal rigidities --- consistent with the evidence in Bils and Klenow [2004] --- lowers the elasticity of import prices at border and consumer level to 27% and 13%, respectively. Still, exchange rate depreciation worsens the terms of trade -- in accord with the evidence stressed by Obstfeld and Rogoff [2000]. In the long run, ERPT coefficients are also below one, as a result of price discrimination. We run a set of regressions adopted by the empirical literature on ERPT, typically plagued by omitted variable bias and measurement errors, on the time series generated by our model. The ERPT estimates are biased, although in most cases reasonable; most regressions can detect differences between short-run and long-run ERPT. We show that the quality of empirical proxies for marginal costs and demand typically vary depending on the shocks (real vs. nominal) hitting the economy.

Keywords: International business cycle; Exchange rate volatility; Pass-through; International transmission; Dsge models (search for similar items in EconPapers)
JEL-codes: F33 F41 (search for similar items in EconPapers)
Date: 2005-12
New Economics Papers: this item is included in nep-dge and nep-ifn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (43)

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Related works:
Journal Article: High exchange-rate volatility and low pass-through (2008)
Working Paper: DSGE Models of High Exchange-Rate Volatility and Low Pass-Through (2005)
Working Paper: DSGE models of high exchange-rate volatility and low pass-through (2005)
Working Paper: Pass-Through and Exchange-Rate Fluctuations in a DSGE Model of Price (2005)
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