Real Exchange Rate Fluctuations and Tradability of Goods in Chile-US International Trade

Andres Sanger T.

doi:10.4067/S0718-88702011000200001

Authors

Andres Sanger T. Banco Central de Chile

DOI:

https://doi.org/10.4067/S0718-88702011000200001

Keywords:

Real exchange rate, Law of One Price, tradability of goods, transaction costs, real business cycles

Abstract

Trade data shows that real exchange rate fluctuates more than other variables such as consumption and GDP, and also presents significant deviations from the Law of One Price. In light of these facts, this paper develops and estimates a non-monetary DSGE model under financial autarky for the international trade of goods and services between Chile and the U.S. In this context, the higher volatility of the real exchange rate is explained by the existence of transaction costs and varying degrees of imperfect substitution in consumption between home and foreign goods which endogenously induce a home bias effect. The results reveal that the estimated transaction costs and the asymmetric home bias effect content in the data would be responsible for the low correlation between consumption in both countries and the higher real exchange rate fluctuations. Finally, the model is able to replicate much of the stylized facts observed in the data, but fails to address the Backus-Smith puzzle.

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