TY  - JOUR
AU  - Devereux,Michael B.
AU  - Engel,Charles
TI  - Exchange Rate Pass-Through, Exchange Rate Volatility, and Exchange Rate Disconnect
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 8858
PY  - 2002
Y2  - March 2002
UR  - http://www.nber.org/papers/w8858
L1  - http://www.nber.org/papers/w8858.pdf
N1  - Author contact info:
Michael B. Devereux
Department of Economics
University of British Columbia
997-1873 East Mall
Vancouver, BC V6T 1Z1
CANADA
Tel: 604/822-2542
Fax: 604/822-5915
E-Mail: mbdevereux@gmail.com

Charles Engel
Department of Economics
University of Wisconsin
1180 Observatory Drive
Madison, WI  53706-1393
Tel: 608/262-3697
Fax: 608/262-2033
E-Mail: cengel@ssc.wisc.edu
AB  - This paper explores the hypothesis that high volatility of real and nominal exchange rates may be due to the fact that local currency pricing eliminates the pass-through from changes in exchange rates to consumer prices.  Exchange rates may be highly volatile because in a sense they have little effect on macroeconomic variables.  The paper shows the ingredients necessary to construct such an explanation for exchange rate volatility.  In addition to the presence of local currency pricing, we need a) incomplete international financial markets, b) a structure of international pricing and product distribution such that wealth effects of exchange rate changes are minimized, and c) stochastic deviations from uncovered interest rate parity. Together, it is shown that these elements can produce exchange rate volatility that is much higher than shocks to economic fundamentals, and `disconnected' from the rest of the economy in the sense that the volatility of all other macroeconomic aggregates are of the same order as that of fundamentals.
ER  -