Real Exchange Rates and Primary Commodity Prices

Joao Ayres, Constantino Hevia and Juan Pablo Nicolini

No 584, Staff Report from Federal Reserve Bank of Minneapolis

Abstract: In this paper, we show that there is substantial comovement between prices of primary commodities such as oil, aluminum, maize, or copper and real exchange rates between developed economies such as Germany, Japan, and the United Kingdom against the US dollar. We therefore explicitly consider the production of commodities in a two-country model of trade with productivity shocks and shocks to the supplies of commodities. We calibrate the model so as to reproduce the volatility and persistence of primary commodity prices and show that it delivers equilibrium real exchange rates that are as volatile and persistent as in the data. The model rationalizes an empirical strategy to identify the fraction of the variance of real exchange rates that can be accounted for by the underlying shocks, even if those are not observable. We use this strategy to argue that shocks that move primary commodity prices account for a large fraction of the volatility of real exchange rates in the data. Our analysis implies that existing models used to analyze real exchange rates between large economies that mostly focus on trade between differentiated final goods could benefit, in terms of matching the behavior of real exchange rates, by also considering trade in primary commodities.

Keywords: Real exchange rate disconnect puzzle; Primary commodity prices (search for similar items in EconPapers)
JEL-codes: F31 F41 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2019-05-09
New Economics Papers: this item is included in nep-opm
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Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Real exchange rates and primary commodity prices (2020)
Working Paper: Real Exchange Rates and Primary Commodity Prices (2019)
Working Paper: Real Exchange Rates and Primary Commodity Prices (2017)
Working Paper: Real Exchange Rates and Commodity Prices (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedmsr:584

DOI: 10.21034/sr.584

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