Trade Costs and Real Exchange Rate Volatility : The Role of Ricardian Comparative Advantage

Author/Editor:

International Monetary Fund

Publication Date:

January 1, 2005

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

This paper examines the impact of trade costs on real exchange rate volatility. We incorporate a multi-country Ricardian model of trade, based on the work of Eaton and Kortum (2002), into a macroeconomic model to show how bilateral real exchange rate volatility depends on relative technological differences and trade costs. These differences highlight a new channel, in which the similarity of a pair of countries' set of suppliers of traded goods affects bilateral exchange rate volatility. We then test the importance of this channel using a large panel of cross-country data over 1970-97, and find strong evidence supporting the channel.

Series:

Working Paper No. 05/5

Subject:

English

Publication Date:

January 1, 2005

ISBN/ISSN:

9781451860245/1018-5941

Stock No:

WPIEA2005005

Format:

Paper

Pages:

43

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