Mussa Puzzle Redux

Oleg Itskhoki and Dmitry Mukhin

No 28950, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The Mussa (1986) puzzle is the observation of a sharp and simultaneous increase in the volatility of both nominal and real exchange rates following the end of the Bretton Woods System of pegged exchange rates in 1973. It is commonly viewed as a central piece of evidence in favor of monetary non-neutrality because it is an instance in which a change in the monetary regime caused a dramatic change in the equilibrium behavior of a real variable (the real exchange rate) and is often further interpreted as direct evidence in favor of models with nominal rigidities in price setting. This paper shows that the data do not support this latter conclusion because there was no simultaneous change in the properties of the other macro variables, nominal or real. We show that an extended set of Mussa facts equally falsifies both conventional flexible-price RBC models and sticky-price New Keynesian models as explanations for the Mussa puzzle. We present a resolution to the broader Mussa puzzle based on a model of segmented financial market — a particular type of financial friction by which the bulk of the nominal exchange rate risk is held by financial intermediaries and is not shared smoothly throughout the economy. We argue that rather than discriminating between models with sticky versus flexible prices, or monetary versus productivity shocks, the Mussa puzzle provides sharp evidence in favor of models with monetary non-neutrality arising in the financial market, suggesting the importance of monetary transmission via the risk premium channel.

JEL-codes: E30 E40 E50 F30 F40 G10 (search for similar items in EconPapers)
Date: 2021-06
New Economics Papers: this item is included in nep-cba, nep-cwa, nep-dge, nep-ifn, nep-mac, nep-mon and nep-opm
Note: AP EFG IFM ME
References: Add references at CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://www.nber.org/papers/w28950.pdf (application/pdf)

Related works:
Working Paper: Mussa Puzzle Redux (2021)
Working Paper: Mussa Puzzle Redux (2019)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:28950

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w28950

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().