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INVESTMENT AND REAL EXCHANGE RATES IN STICKY PRICE MODELS

Published online by Cambridge University Press:  25 May 2012

Enrique Martínez-García  and
Jens Søndergaard
Enrique Martínez-García*
Affiliation:
Federal Reserve Bank of Dallas
Jens Søndergaard
Affiliation:
Nomura International plc
*
Address correspondence to: Enrique Martínez-García, Federal Reserve Bank of Dallas, 2200 N. Pearl Street, Dallas, TX 75201, USA; e-mail: enrique.martinez-garcia@dal.frb.org; URL: http://dallasfed.org/research/bios/martinez-garcia.html.
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Abstract

This paper investigates how the inclusion of capital in the workhorse new open economy macro model affects its ability to generate volatile and persistent real exchange rates. We show that capital accumulation facilitates intertemporal consumption smoothing and significantly reduces the volatility of the real exchange rate. Nonetheless, monetary and investment-specific technology (IST) shocks still induce more real exchange rate volatility and less consumption comovement than productivity shocks (with or without capital). We find that endogenous persistence is particularly sensitive to the inertia of the monetary policy rule even with persistent exogenous shocks. However, irrespective of whether capital is present, productivity and IST shocks trigger highly persistent real exchange rates, whereas monetary shocks do not. Moreover, we point out that IST shocks tend to generate countercyclical real exchange rates—unlike productivity or monetary shocks—but have the counterfactual effect of also producing excessive investment volatility and countercyclical consumption.

Keywords

Real Exchange RatesCapital AccumulationSticky PricesLocal-Currency Pricing
Type
Articles
Information
Macroeconomic Dynamics , Volume 17 , Issue 2 , March 2013 , pp. 195 - 234
Copyright
Copyright © Cambridge University Press 2012

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