The Puzzling Behavior of Sectoral Real Exchange Rates

Virgiliu Midrigan and Patrick Kehoe

No 1270, 2009 Meeting Papers from Society for Economic Dynamics

Abstract: The classic explanation for the persistence and volatility of real exchange rates is that they are the result of nominal shocks in an economy with sticky goods prices. A key implication of this explanation is that if goods in different sectors have different degrees of price stickiness then goods in the relatively sticky sectors tend to have relatively more persistent and volatile good-level real exchange rates. Using panel data, we find only modest support for these key implications. An alternative explanation is that the real exchange rates are driven by real productivity shocks, so that goods with more volatile and persistent real exchange rates should be in sectors with more volatile and persistent productivity shocks. We find little evidence for this explanation as well. In sum, cross section data is puzzling for existing models of real exchange rates.

Date: 2009
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