[2003-02]   Accounting for Real Exchange Rate Changes with Individual Goods

by David C. Parsley and Helen A. Popper

Abstract

TIn this paper, we examine the role of individual goods’ prices in explaining real exchange rate
fluctuations. We show that deviations from the law of one price in even a single good, such
as a haircut, can account for virtually all of the real exchange rate movements. We compare
this finding with that of Engel (1999), who shows that virtually all of the fluctuation can be
accounted for by aggregate deviations from the law of one price in traded goods.