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

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  • Caroline M. Betts
  • Timothy J. Kehoe

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.

Suggested Citation

  • Caroline M. Betts & Timothy J. Kehoe, 2004. "U.S. real exchange rate fluctuations and relative price fluctuations," Staff Report 334, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmsr:334
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    More about this item

    Keywords

    International trade; Monetary policy; Foreign exchange rates; Prices; International finance;
    All these keywords.

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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