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Working Paper
“Conditional PPP” and Real Exchange Rate Convergence in the Euro Area
While economic theory highlights the usefulness of flexible exchange rates in promoting adjustment in international relative prices, flexible exchange rates also can be a source of destabilizing shocks. We find that when countries joining the euro currency union abandoned their national exchange rates, the adjustment of real exchange rates toward their long-run equilibrium surprisingly became faster. To investigate, we distinguish between differing rates of purchasing power parity (PPP) convergence conditional on alternative shocks, which we refer to as ?conditional PPP.? We find that the ...
Journal Article
Should we worry about the large U.S. current account deficit?
Is the large current account deficit a problem for the U.S.? Economic theory offers some scenarios in which a current account deficit is a rational response to economic conditions or a response that may even enhance economic welfare. At the same time, recent research suggests that under certain circumstances, a large current account deficit may make the U.S. economy vulnerable to severe disruptions. This Economic Letter explores some recent theories and some data to understand how the current account deficit could be either an optimal outcome or a threatening one.
Working Paper
Tradability, productivity, and understanding international economic integration
This paper develops a two-country macro model with endogenous tradability to study features of international economic integration. Recent episodes of integration in Europe and North America suggest some surprising observations: while quantities of trade have increased significantly, especially along the extensive margin of goods previously not traded, price dispersion has not decreased and may even have increased. These observations challenge the usual understanding of integration in the literature. We propose a way of reconciling these price and quantity observations in a macroeconomic model ...
Working Paper
A model of endogenous nontradability and its implications for the current account
This paper analyzes how a model where goods are endogenously nontraded can help explain the relationship between the current account and real exchange rate fluctuations. We formulate a small open economy two-period model in which goods switch endogenously between being traded or nontraded. The model demonstrates how movements in the real exchange rate and real interest rate can impose significant costs on intertemporal trade. The model also shows that a variety of nonlinear relationships is possible between the current account and real exchange rate, depending on the relative transport costs ...
Journal Article
Asset price booms and current account deficits
Before the global financial crisis of 2007?2009, the United States and several other countries posted large current account deficits. Many of these countries also experienced asset price booms. Evidence suggests the two developments were linked. Rising asset values in the United States permitted households to borrow more easily to boost consumption, while the net sale of debt securities abroad financed current account deficits. The fall in some asset prices since the crisis can make it easier to reduce current account imbalances.
Journal Article
Measuring the costs of exchange rate volatility
Many countries go to great lengths to manage their exchange rates. Probably the most prominent recent example is the European Monetary Union, where all the members abandoned their national currencies and adopted the euro. A number of developing countries maintain other kinds of regimes of managed exchange rates, even though they face potent market pressures to let their exchange rates float. One of the main motives for these arrangements stems from the extreme volatility of exchange rates. This volatility introduces an element of uncertainty into doing business across borders. Arguably, this ...
Working Paper
Mussa redux and conditional PPP
Long half-lives of real exchange rates are often used as evidence against monetary sticky price models. In this study we show how exchange rate regimes alter the long-run dynamics and half-life of the real exchange rate, and we recast the classic defense of such models by Mussa (1986) from an argument based on short-run volatility to one based on long-run dynamics. The first key result is that the extremely persistent real exchange rate found commonly in post Bretton Woods data does not apply to the preceding fixed exchange rate period in our sample, where the half-live was roughly half as ...
Journal Article
Is there a role for international policy coordination?
As the U.S. struggles with its first economic slowdown in a decade, so do most of the major industrialized countries. Japan is sliding again into recession, with third quarter GDP growth of -2.2%. Europe also seems to be slowing, with a third quarter growth rate of 0.4% for the euro area as a whole, and -0.6% for Germany in particular. ; This concurrent slowdown may not seem so surprising, given the increasing globalization and integration of the world's economies. For example, it may be that countries now face common shocks, such as a change in oil prices or a productivity slowdown; or, it ...
Working Paper
The micro-macro disconnect of purchasing power parity
The persistence of aggregate real exchange rates is a prominent puzzle, particularly since adjustment of international relative prices in microeconomic data is much faster. This paper finds that adjustment to the law of one price in disaggregated data is not just a faster version of the adjustment to purchasing power parity in the aggregate data; while aggregate real exchange rate adjustment works primarily through the foreign exchange market, adjustment in disaggregated data is a qualitatively distinct process, working through adjustment in local-currency goods prices. These distinct ...