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The role of heterogeneity in price rigidities for delayed nominal exchange rate overshooting

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  • Cooke, Dudley
  • Kara, Engin

Abstract

This paper develops an open economy New Keynesian model in which shocks to monetary policy generate delayed nominal exchange rate overshooting. We show analytically that delayed overshooting is a consequence of heterogeneity in nominal price rigidities. Immediately after a contractionary monetary shock, the reaction of firms with relatively flexible prices generates a strong response of inflation, alongside a currency appreciation. Overtime, as firms with relatively less flexible prices adjust, the appreciation continues, but is subsequently followed by a depreciation. In a calibrated version of the model, with heterogeneity in price rigidity matched with micro-evidence, the peak response of the nominal exchange rate to a monetary policy shock occurs at around 4 quarters.

Suggested Citation

  • Cooke, Dudley & Kara, Engin, 2022. "The role of heterogeneity in price rigidities for delayed nominal exchange rate overshooting," Journal of International Money and Finance, Elsevier, vol. 120(C).
    • Handle: RePEc:eee:jimfin:v:120:y:2022:i:c:s0261560621001923
    DOI: 10.1016/j.jimonfin.2021.102541
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    More about this item

    Keywords

    Heterogeneity in price rigidities; Monetary policy shocks; Nominal exchange rate;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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