Pricing-to-market, staggered contracts, and real exchange rate persistence

This paper explores an explanation for the high degree of persistence and volatility observed in real exchange rate data. In particular, it considers a class of preferences that are translogin Form, which exhibit the property that the elasticity of demand is not constant. This property is shown to he important for generating pricing-to-market behavior in price-setting firms and for helping staggered contracts to generate endogenous persistence. The paper finds that translog preferences generate significantly greater persistence in the real exchange rare than does the standard CES specification. While the model cannot fully reproduce the high level of persistence observed in the data under plausible parameter values, it can reproduce the level of volatility. (C) 2001 Elsevier Science B.V. All rights reserved.