Real Exchange Rate Dynamics With Endogenous Distribution Costs

MPRA Paper from University Library of Munich, Germany

Abstract: The importance of distribution costs in generating the deviations from the law of one price has been well documented. In this paper we show that a two-country flexible price dynamic general equilibrium model driven by exogenous innovations to technology, and with a localized distribution services sector can replicate the key dynamic features of the real exchange rate. In doing so, the paper identifies the importance of two key channels for real exchange rate dynamics. That is, we show: (i) that shocks in the real sector are important contributors to movements in the real exchange rate, and (ii) that the endogenous wedge created by distribution costs of traded goods is a significant source of fluctuation for the real exchange rate, and the overall macro-economy as a whole. The evidence presented here demonstrates that this model - without any nominal rigidities, can account for up to 89% of the relative volatility in the real exchange rate.

Keywords: Distribution costs; Real exchange rate dynamics; Law of one price (search for similar items in EconPapers)
JEL-codes: E32 E37 F41 (search for similar items in EconPapers)
Date: 2006-09
New Economics Papers: this item is included in nep-cba, 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 (1)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:9

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