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

Giancarlo Corsetti, Luca Dedola () and Sylvain Leduc

No ECO2005/23, Economics Working Papers from European University Institute

Abstract: This paper develops a quantitative, dynamic, open-economy model which endogenously generates high exchange rate volatility, whereas a low degree of pass-through 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. 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. Remarkably, exchange rate depreciation worsens the terms of trade - in accord to the evidence stressed by Obstfeld and Rogo [2000]. In the long run, exchange-rate pass-through coefficients are also below one, as a result of price discrimination. The latter is an implication of distribution services, which makes the goods demand elasticity market specific.

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
New Economics Papers: this item is included in nep-dge, nep-fmk, nep-ifn and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (39)

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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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