Pricing-to-Market, Staggered Contracts, and Real Exchange Rate Persistence

Abstract

: This paper explores an explanation for the high degree of persistence and volatility observed in real exchange rate data. In particular, it considers a class of preferences that are translog in form, which exhibit the property that the elasticity of demand is not constant. This property is shown to be important for generating pricing-to-market behavior in price-setting firms and for helping staggered contracts to generate endogenous persistence. The paper finds that translog preferences generate significantly greater persistence in the real exchange rate than does the standard CES specification. While the model cannot fully reproduce the high level of persistence observed in the data under plausible parameter values, it can reproduce the level of volatility. Key Words: real exchange rate, endogenous persistence, pricing-to-market JEL Classification: F41, F31 ________________________ Special thanks go to Charles Engel and Patrick Asea for detailed comments. We also thank ...

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