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Trade Costs and Real Exchange Rate Volatility: The Role of Ricardian Comparative Advantage

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  • International Monetary Fund

Abstract

This paper examines the impact of trade costs on real exchange rate volatility. We incorporate a multi-country Ricardian model of trade, based on the work of Eaton and Kortum (2002), into a macroeconomic model to show how bilateral real exchange rate volatility depends on relative technological differences and trade costs. These differences highlight a new channel, in which the similarity of a pair of countries' set of suppliers of traded goods affects bilateral exchange rate volatility. We then test the importance of this channel using a large panel of cross-country data over 1970-97, and find strong evidence supporting the channel.

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  • International Monetary Fund, 2005. "Trade Costs and Real Exchange Rate Volatility: The Role of Ricardian Comparative Advantage," IMF Working Papers 2005/005, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2005/005
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    1. Mr. Ayhan Kose & Mr. Roberto Cardarelli, 2004. "Economic Integration, Business Cycle, and Productivity in North America," IMF Working Papers 2004/138, International Monetary Fund.
    2. M. Ayhan Kose & Guy M. Meredith & Christopher M. Towe, 2005. "How Has NAFTA Affected the Mexican Economy? Review and Evidence," Springer Books, in: Rolf J. Langhammer & Lúcio Vinhas Souza (ed.), Monetary Policy and Macroeconomic Stabilization in Latin America, pages 35-81, Springer.
    3. Kanda Naknoi, 2005. "Real Exchange Rate Fluctuations and Endogenous Tradability," 2005 Meeting Papers 857, Society for Economic Dynamics.
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