NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies

Enrique G. Mendoza

NBER Working Paper No. 11691
Issued in October 2005
NBER Program(s):   IFM

The dominant view in the empirical literature on exchange rates is that the high variability of real exchange rates is due to movements in exchange-rate-adjusted prices of tradable goods. This paper shows that this dominant view does not hold in Mexican data for the periods in which the country had managed exchange rate regimes. Variance analysis of a 30-year sample of monthly data shows that movements in the price of nontradables relative to tradables account for up to 70 percent of the variability of the real exchange rate during these periods. The paper proposes a model in which this stylized fact, and the Sudden Stops that accompanied the collapse of Mexico's managed exchange rates, could result from an endogenous amplification mechanism operating via nontradables prices in economies with dollarized liabilities and credit constraints. The key feature of this mechanism is Irving Fisher's debt-deflation process. Numerical evaluation suggests that the Fisherian deflation effects on consumption, the current account, and relative prices dwarf those induced by the standard balance sheet effect typical of the Sudden Stops literature.

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Document Object Identifier (DOI): 10.3386/w11691

Published: Mendoza, Enrique G. “Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies.” Economia 6, 1 (Fall 2005).

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