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The role of heterogeneity in price rigidities for delayed nominal exchange rate overshooting

Dudley Cooke (dkcooke@gmail.com) and Engin Kara

Journal of International Money and Finance, 2022, vol. 120, issue C

Abstract: This paper develops an open economy New Keynesian model in which shocks to monetary policy generate delayed nominal exchange rate overshooting. We show analytically that delayed overshooting is a consequence of heterogeneity in nominal price rigidities. Immediately after a contractionary monetary shock, the reaction of firms with relatively flexible prices generates a strong response of inflation, alongside a currency appreciation. Overtime, as firms with relatively less flexible prices adjust, the appreciation continues, but is subsequently followed by a depreciation. In a calibrated version of the model, with heterogeneity in price rigidity matched with micro-evidence, the peak response of the nominal exchange rate to a monetary policy shock occurs at around 4 quarters.

Keywords: Heterogeneity in price rigidities; Monetary policy shocks; Nominal exchange rate (search for similar items in EconPapers)
JEL-codes: E52 F41 F44 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:120:y:2022:i:c:s0261560621001923

DOI: 10.1016/j.jimonfin.2021.102541

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