Premium
Why is the business‐cycle behaviour of fundamentals alike across exchange‐rate regimes?
Author(s) -
Dedola Luca,
Leduc Sylvain
Publication year - 2001
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/ijfe.169
Subject(s) - economics , business cycle , exchange rate , monetary economics , macroeconomics , international economics
Since the adoption of flexible exchange rates, real exchange rates have been much more volatile than they were under Bretton Woods. However, the volatilities of most other macroeconomic variables have remained approximately unchanged. This poses a puzzle for standard international business cycle models. This paper develops a two‐country, two‐sector model with nominal rigidities featuring deviations from the law of one price due to firms setting prices in buyers' currencies. By partially insulating goods markets across countries and thus mitigating the international expenditure‐switching effect, this pricing behaviour is found to considerably dampen the responses of quantities to shocks hitting the economies therefore helping to account for the puzzle. Copyright © 2001 John Wiley & Sons, Ltd.