Revisiting Real Exchange Rate Volatility: Nontraded Goods and Cointegrated TFP Chockse
UB Economics Working Papers E18/375
32 Pages Posted: 1 May 2018
Date Written: April 11, 2018
Abstract
International real business cycle (IRBC) models predict a real exchange rate volatility that is much lower than the levels observed in the data. In this paper, we build a two-country IRBC model with both a traded and a non-traded goods sector, and calibrate it to UK-euro area (EA) data. We provide evidence on the existence of a cointegrating relationship between UK and EA traded sector total factor productivity (TFP) by estimating a vector error correction model (VECM). To account for this relationship, we incorporate non-stationary technology shocks in the traded sectors in our model, and show that then the model is able to match the observed volatility of the UK-EA real exchange rate. Our analysis points out that both the presence of non-traded sectors and non-stationary technology shocks are necessary to account for the observed volatility in the real exchange rate.
Keywords: Real Exchange Rates, Non-Traded Goods, Cointegration
JEL Classification: E32, F41, F44.
Suggested Citation: Suggested Citation