Research

This paper studies the drivers of the US real exchange rate (RER), with a particular focus on its comovement with net trade (NT) flows. We consider the entire spectrum of frequencies, as the low-frequency variation accounts for 61 and 64 percent of the unconditional variance of the RER and NT, respectively. We develop a generalization of the standard international business cycle model that successfully rationalizes the joint dynamics of the RER and NT while accounting for the major puzzles of the RER. We find that, while financial shocks are necessary to capture high frequency variation in RER, trade shocks are essential for the lower frequency fluctuations. 

The macroeconomic effects of trade policy depend on how it affects relative prices and how quickly trade quantities respond. We study how monetary/exchange rate regimes and dynamic trade elasticities shape this transmission, exploiting China’s policy changes during the 2008 global financial crisis, when a 4.1 percentage-point reduction in the effective export tax coincided with the adoption of a peg. At the product level, we find that changes in export taxes pass through rapidly to export prices, while quantities adjust gradually over time. We then develop a Markov-Switching DSGE framework in which the transmission of export taxes depends on the dynamic trade elasticity, the monetary and exchange rate regime, and expectations about future regime reversals. We find that export tax reductions are more expansionary under a peg, while a constant trade elasticity misstates the timing and magnitude of the response. For the 2008 episode, the model implies that the export tax reduction increased China’s real exports relative to imports, GDP, and consumption by around 3.0, 1.0, and 0.5 percentage points, respectively.