Can international macroeconomic models explain low-frequency movements of real exchange rates? ¬リニ

a r t i c l e i n f o Real exchange rates exhibit important low-frequency fluctuations. This makes the analysis of real exchange rates at all frequencies a more sound exercise than the typical business cycle one, which compares actual and simulated data after the Hodrick-Prescott filter is applied to both. A simple two-country, two-good, international real business cycle model can explain the volatility of the real exchange rate when all frequencies are studied. The puzzle is that the model generates too much persistence of the real exchange rate instead of too little, as the business cycle analysis asserts. We show that the introduction of input adjustment costs in production, cointegrated productivity shocks across countries, and lower home bias allows us to reconcile theory and this feature of the data. This paper challenges the conventional wisdom that a baseline international real business cycle (IRBC) two-country, two-good model cannot generate either enough volatility or enough persistence in the real exchange rate (RER) when compared to the data. When the object of interest is RER fluctuations at all frequencies, instead of business cycle (BC) frequencies only, this model can explain the standard deviation of the U.S. dollar RER. However, the model implies a higher persistence of the RER than in the data. We advocate that analyzing RER fluctuations at all frequencies is a more compelling exercise than just studying the BC ones. Spectral analysis shows that most of the variance of the RER in the data can be assigned to low-frequency movements (about 70%), while movements at BC frequencies account for only a small share of the RER fluctuations (just 25%). The baseline IRBC model accounts for the area below the spectrum of the RER, i.e., its standard deviation, but not for its shape, since it places a larger share of fluctuations of the RER in low-frequency movements than occurs in the data. We call this shortcoming of the model the " excess persistence of the RER " puzzle. We show that extending the model to consider adjustment costs in the composition of domestic and imported intermediate inputs and lower home bias helps to solve this puzzle (i.e., replicating the shape of the spectrum) while still explaining the standard deviation of the RER (i.e., the area below the spectrum). Since the seminal works of Backus et al. (1992) and Baxter and Crucini (1995), the IRBC literature has been preoccupied with …