Volatile and persistent real exchange rates without the contrivance of sticky prices

Maurice Roche and Michael Moore

Economics Department Working Paper Series from Department of Economics, National University of Ireland - Maynooth

Abstract: The flexible-price two-country monetary model is extended to include a consumption externality with habit persistence. The model is simulated using the artificial economy methodology. It successfully explains (i) the high volatility of nominal and real exchange rates, (ii) the high correlation between real and nominal rates, and (iii) the persistence of real exchange rates. It offers a neo-classical explanation for the Meese-Rogoff exchange rate forecasting puzzle.

Date: 2002-04
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