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

Abstract

This paper develops a quantitative, dynamic, open-economy model which endogenously generates high exchange rate volatility, whereas a low degree of exchange rate pass-through (ERPT) 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. We show that, in our framework, both approaches are successful in generating volatility without suffering from shortcomings such as a fall in import volatility, or the need for nominal shocks. 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. Still, exchange rate depreciation worsens the terms of trade-in accord with the evidence stressed by Obstfeld and Rogoff [2000]. In the long run, ERPT coefficients are also below one, as a result of price discrimination. We run a set of regressions adopted by the empirical literature on ERPT, typically plagued by omitted variable bias and measurement errors, on the time series generated by our model. The ERPT estimates are biased, but in most cases not off the mark; most regressions can detect differences between short-run and long-run ERPT. We show that the quality of empirical proxies for marginal costs and demand typically vary depending on the shocks (real vs. nominal) hitting the economy.

Exchange Rate Pass‐through to Trade Prices: The Role of Nonlinearities and Asymmetries*

“…2 2 This model is very similar to Yang (1997), Marazzi et al. (2005), Corsetti et al. (2005), Ihrig et al.…”

Exchange Rate Pass‐Through in a Competitive Model of Pricing‐to‐Market

“…Our model is related to a second strand of the literature. The seminal papers of Krugman (1987) and Dornbusch (1987) have been followed by more elaborate models, such as Yang (1997), Corsetti, Dedola, and Leduc (2005), and Atkeson and Burstein (Forthcoming). These models rely on the fact that, when firms adjust their prices, they move along the demand curve and face a different demand elasticity.…”

Monetary Policy Choices in Emerging Market Economies: The Case of High Productivity Growth

“…11 11 While we model incomplete pass‐through using nominal rigidities in the import sector, alternative modeling choices, such as accounting for the existence of distribution costs, have been explored in the literature (see Corsetti, Dedola, and Leduc 2005) …”