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Understanding the Effect of Productivity Changes on International Relative Prices: The Role of News Shocks
Author(s) -
Nam Deokwoo,
Wang Jian
Publication year - 2018
Publication title -
pacific economic review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.34
H-Index - 33
eISSN - 1468-0106
pISSN - 1361-374X
DOI - 10.1111/1468-0106.12200
Subject(s) - economics , dynamic stochastic general equilibrium , total factor productivity , productivity , relative price , shock (circulatory) , monetary economics , small open economy , capital (architecture) , general equilibrium theory , capital good , macroeconomics , odds , open economy , exchange rate , econometrics , terms of trade , goods and services , monetary policy , economy , medicine , history , logistic regression , archaeology
The US real exchange rate and terms of trade have been found to appreciate when US labour productivity increases relative to the rest of the world. This finding is at odds with predictions from standard international macroeconomic models. In this paper, we find that incorporating news shocks to total factor productivity (TFP) in an otherwise standard open‐economy sticky‐price dynamic stochastic general equilibrium (DSGE) model with variable capital utilization can help the model replicate the above empirical finding. Labour productivity increases in our model after a positive news shock to TFP because of an increase in capital utilization. Under some plausible calibrations, the wealth effect of good news about future productivity can increase domestic demand strongly and induce an increase in home goods prices relative to foreign goods prices.