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Understanding Real Exchange Rate Movements with Trade in Intermediate Products
Pacific Economic Review (2010)
  • David C. Parsley
  • Helen Popper
This paper reexamines decompositions of the real exchange rate that apportion its movements into a part that reflects international deviations from the law of one price and a part that reflects the relative prices of traded and nontraded goods within countries. Using Japanese and U.S. data, we first show that in such decompositions the traded/nontraded distinction is irrelevant at the consumer level. Next, motivated by a model of trade in intermediate products, we use implied import weights and find that relative traded/nontraded price changes, appropriately defined, can account for much of the real exchange rate's variation. These findings contrast sharply with earlier results that attribute real exchange rate movements to deviations in the law of one price; and, they provide fresh support for traditional real exchange rate models which rely on the distinction between the open and closed sectors of the economy.
  • Real Exchange Rates,
  • PPP,
  • MSE decomposition
Publication Date
August, 2010
Citation Information
David C. Parsley and Helen Popper. "Understanding Real Exchange Rate Movements with Trade in Intermediate Products" Pacific Economic Review Vol. 15 Iss. 2 (2010)
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