Understanding Real Exchange Rates

Vanderbilt University, Nashville TN

Investigators

Abstract

This research proposal is divided into three sections. The first section describes ongoing efforts to build a large public-use micro-price archive patterned after the International Comparison Project. Key differences are the level of aggregation and the frequency of data. The ICP is based on international price surveys at 5-year intervals, interpolated to annual frequencies. Aggregation across goods and locations is conducted by national statistical agencies. Aggregation across locations within a country is necessary to achieve the goal of producing a national deflator. This project's ongoing efforts to compile micro-price data are motivated by a desire to unearth empirical facts that more clearly distinguish alternative theories of relative price determination than is possible with data commonly available. For example, the New Open Economy Macroeconomics is built upon the assumption that the Law-of-One-Price holds in the steady-state and that all goods are equally 'sticky' (usually) in domestic currency terms. This contrasts with the conventional dichotomy between traded and non-traded goods, with traded goods having smaller steady-state deviations from the Law-of-One-Price (i.e., shipping costs) and adjusting more quickly to the steady-state than non-traded goods. In our view this debate has been systematically biased by the use of aggregative index number data in place of micro-data. Aggregation is problematic because it inevitably involves averaging of deviations across traded and non-traded goods, thereby obscuring the differences between the two. The research from the previous NSF award demonstrated how the characteristics of goods (extent of trade and importance of non-traded inputs) influenced geographic price dispersion and relative price persistence. However, the investigators faced data limitations: their results on geographic price dispersion were confined to the EU while those for persistence involved the OECD and a sub-set of developing countries over a limited time period (the 1990s). The second section of this proposal uses the Economist Intelligence Unit data, spanning both intranational and global price comparisons to explore the earlier results in a broader empirical setting. The investigators organize their analysis around a simple partial equilibrium model of retail price determination in which each retail good is a composite of a traded and non-traded input. Taking various "cuts" at the data (i.e. cross-sectional, time series, geographic, and good-specific variation), the investigators demonstrate the model's ability to match many features of the data. The third part of the project will examine the robustness of prior findings in novel empirical settings; take the empirical work in new directions; and will assess the relative merit of alternative state-of-the-art models in accounting for the cross-sectional and time series behavior of international relative prices from the level of individual goods up to aggregative price levels. Broader Impacts: The data from this project archives will be at the level of individual goods and services in particular locations (typically these will be large cities, though some of the data extends down to the level of retail establishments). Each individual archive represents a substantial increase in available micro-data in existence for research purposes. The investigators also plan to make existing micro-price databases that have been used in published research available on the same internet site.