The real exchange-rate puzzles is a common term for two much-discussed anomalies of

real exchange rate In finance, an exchange rate is the rate at which one currency will be exchanged for another currency. Currencies are most commonly national currencies, but may be sub-national as in the case of Hong Kong or supra-national as in the case of t ...

s: that real exchange rates are more '' volatile'' and show more ''persistence'' than what most models can account for. These two anomalies are sometimes referred to as the ''purchasing power parity puzzles''. Dornbusch's (1976) exchange rate overshooting hypothesis argued that exchange rate volatility is essentially driven by monetary shocks interacting with

sticky prices Nominal rigidity, also known as price-stickiness or wage-stickiness, is a situation in which a nominal price is resistant to change. Complete nominal rigidity occurs when a price is fixed in nominal terms for a relevant period of time. For exampl ...

. This model can account for real exchange rate volatility, but does not say anything about the volatility of relative to

output Output may refer to: * The information produced by a computer, see Input/output * An output state of a system, see state (computer science) * Output (economics), the amount of goods and services produced ** Gross output in economics, the value of ...

or the persistence of the real exchange rate movements.

Chari Chari may refer to: Places * Chari River, in Central Africa * Chari-Baguirmi (disambiguation), in Chad * Chari Department, in Chad, one of three departments making up the region of Chari-Baguirmi * Moyen-Chari (disambiguation), in Chad * Chari, ...

, Kehoe and McGrattan (2002) showed how a model with two countries and where prices were only allowed to change once-a-year had the potential to simultaneously account for the volatility of U.S. output and real exchange rates. These two anomalies are related to, but should not be confused with, the Backus-Smith consumption-real exchange rate anomaly, which is the observation that in most economic models the correlation between the real exchange rate and relative consumption is high and positive, whereas in the data it ranges from small and positive to negative. Another real-exchange-rate anomaly was documented by Mussa (1986). In this paper Mussa documented that industrial countries which moved from fixed to

floating exchange rate In macroeconomics and economic policy, a floating exchange rate (also known as a fluctuating or flexible exchange rate) is a type of exchange rate regime in which a currency's value is allowed to fluctuate in response to foreign exchange mar ...

regimes experienced dramatic rises in nominal-exchange-rate volatility. Since the volatility increases much more than what can be accounted for by changes in the domestic price levels, it means that the real-exchange-rate volatility increases. This is sometimes referred to as the «Mussa puzzle». Obstfeld and Rogoff (2000) identified the purchasing power and exchange rate disconnect puzzle as one of the six major puzzles in international economics. These were the consumption correlation puzzle,

home bias in trade puzzle The Home bias in trade puzzle is a widely discussed problem in macroeconomics and international finance, first documented by John T. McCallum in an article from 1995. McCallum showed that for the United States and Canada, inter-province trade is 2 ...

, the

equity home bias puzzle The Home bias puzzle is the term given to describe the fact that individuals and institutions in most countries hold only modest amounts of foreign equity, and tend to strongly favor company stock from their home nation. This finding is regarded as ...

, the Feldstein-Horioka savings-investment correlations puzzle, and the exchange rate regime puzzle. The sixth puzzle is described as "why exchange rates are so volatile and apparently disconnected from fundamentals". Here Obstfeld and Rogoff (2000) quotes the Meese and Rogoff (1983) ''exchange rate forecasting puzzle'' and the Baxter and Stockman (1989) ''neutrality of exchange rate regime puzzle''. These two puzzles are closely to the ''Mussa puzzle'' as well as the other real exchange rate puzzles.

References

{{reflist * Coudert, Virginie and Valérie Mignon.
The Forward Premium Puzzle and the Sovereign Default Risk
, ''Journal of International Money and Finance,'' 2012.

External links

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Economic puzzles Foreign exchange market International macroeconomics

See also

References

External links