The Real Exchange Rate in Sticky Price Models: Does Investment Matter?

Abstract

This paper re-examines the ability of sticky-price models to generate volatile and persistent real exchange rates. We use a DSGE framework with pricing-to-market akin to those in We show that adding capital accumulation to the model facilitates consumption smoothing and significantly impedes the model's ability to generate volatile real exchange rates. Our analysis, therefore, caveats the results in Steinsson ( Finally, we find that the CKM (2002) persistence anomaly remains robust to several alternative capital specifications including set-ups with variable capital utilization and investment adjustment costs (see, e.g., In summary, the PPP puzzle is still very much alive and well.