Report

U.S. real exchange rate fluctuations and relative price fluctuations

Abstract: This paper studies the relation between the United States? bilateral real exchange rate and the associated bilateral relative price of nontraded goods for five of its most important trade relationships. Traditional theory attributes fluctuations in real exchange rates to changes in the relative price of nontraded goods. We find that this relation depends crucially on the choice of price series used to measure relative prices and on the choice of trade partner. The relation is stronger when we measure relative prices using producer prices rather than consumer prices. The relation is stronger the more important is the trade relationship between the United States and a trade partner. Even in cases where there is a strong relation between the real exchange rate and the relative price of nontraded goods, however, a large fraction of real exchange rate fluctuations is due to deviations from the law of one price for traded goods.

Keywords: International trade; Monetary policy; Foreign exchange rates; Prices; International finance;

Status: Published in Journal of Monetary Economics> (Vol. 53, No. 7, October 2006, pp. 1297-1326)

Bibliographic Information

Provider: Federal Reserve Bank of Minneapolis

Part of Series: Staff Report

Publication Date: 2004

Number: 334