Is There an Exchange Rate Channel in the Forward-Looking Phillips Curve? A Theoretical and Empirical Investigation

Alfred Guender and Yu Xie

Working Papers in Economics from University of Canterbury, Department of Economics and Finance

Abstract: This paper shows how the exchange rate affects the price-setting behavior of monopolistically competitive firms in the sticky price framework that gives rise to a forward-looking Phillips Curve at the aggregate level. The open economy Phillips Curve differs from its closed economy counterpart in that the real exchange rate exerts a direct effect on domestic inflation. The exchange rate channel in the Phillips Curve is pivotal in determining the optimal policy setting in an open economy. On balance, we find only scant empirical evidence for the existence of a direct exchange rate channel in the Phillips Curve in a sample of six OECD countries. Indeed, the forward-looking Phillips Curve does not receive much backing from the data. The use of highly aggregated data may account for the poor fit.

Keywords: Open economy Phillips Curve; Exchange rate channel; Output gap (search for similar items in EconPapers)
JEL-codes: E3 F4 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2006-12-01
New Economics Papers: this item is included in nep-cba, nep-ifn and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:cbt:econwp:06/16

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