Exchange Rate Pass-Through, Exchange Rate Volatility, and Exchange Rate Disconnect

By Michael B. Devereux, Charles M. Engel. 2002

435 citations recorded by the source corpus.

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.

View Paper: https://www.semanticscholar.org/paper/e2b1328cf410f3222029d89f545352dd5a6e76be

Citations in the corpus

• Rational speculation and exchange rates (2001, unknown): “In a general equilibrium framework similar to ours, Devereux and Engel (2002) have explored the role of noise traders in foreign exchange markets in explaining the high volatility of exchange rates and their disconnect from other macroeconomic variables.”
• Concepts of equilibrium exchange rates (2005, unknown): “…for the so-called ‘exchange rate disconnect’ puzzle: that is, that large movements in the exchange rate have not been associated with large movements in import and export prices and the consumer price index, as might be suggested by a standard model; see for example Devereux and Engel (2002).”
• Exchange Rate Pass-Through And Monetary Policy (2008, unknown): “…– together with nominal price rigidities implies that exchange rate fluctuations will have less impact on import prices, at least in the short run (Devereux and Engel, 2002; Bacchetta and van Wincoop, 2005; Campa and Goldberg, 2005; Gopinath, Itskhoki, and Rigobon, 2007; Gopinath and Rigobon,…”
• Inflation Dynamics, Marginal Cost, and the Output Gap: Evidence from Three Countries (2005, unknown): “See e.g. Stock and Watson (2001) and Devereux and Engel (2002).”
• A new look at pass-through (2008, unknown): “See Devereux and Engel (2002) and Devereux, Engel, and Storgaard (2003).”
• SIGMA: a new open economy model for policy analysis (2005, unknown): “(e.g., Betts and Devereux (1996) or Devereux and Engel (2002) ).”
• Can Structural Small Open Economy Models Account for the Influence of Foreign Disturbances (2010, unknown): “Second, this specification engenders an extreme version of the exchange rate disconnect puzzle—see Devereux and Engel (2002).”
• Smooth Landing or Crash? Model-Based Scenarios of Global Current Account Rebalancing (2005, unknown): “See, for example, Engel (1993), Engel and Rogers (1996), Rogoff (1996), Obstfeld and Rogoff (2000a,b), Devereux and Engel (2002), Corsetti and Dedola (2002), and Choudhri, Faruqee, and Hakura (2005).”
• Multi-Product Firms and Exchange Rate Fluctuations (2013, unknown): “…international trade literature established rms as the primary 1For examples, see Goldberg and Knetter (1997), Burstein, Neves, and Rebelo (2003), Campa and Goldberg (2005), Campa, Goldberg, and Gonzalez-Minguez (2006), Devereux, Engel, and Tille (1999), and Devereux and Engel (2002) among others.”
• Exchange Rate Disconnect in General Equilibrium (2017, unknown): “3 Exogenous UIP shocks are commonly used in the international macro literature (see, e.g., Devereux and Engel 2002; Kollmann 2005; Farhi and Werning 2012) and can be viewed to emerge from exogenous asset demand, as in the literature following Kouri (1976, 1983).”