Faculty of Business Seminar Series / Engin Kara

Faculty of Business Seminar Series / Engin Kara

Date: Wednesday, March 4th, 2020

Time: 10:00-11:30

Location: AB2, Meeting Room 345

Title: The Role of Heterogeneity in Price Rigidities and Trend Inflation for Delayed Nominal Exchange Rate Overshooting

Abstract: We develop an open economy New Keynesian model in which shocks to monetary policy generate delayed nominal exchange rate overshooting. The main insight of our analysis is that such exchange rate dynamics are a consequence of the interaction between heterogeneity in nominal price rigidities and positive trend inflation. Whilst heterogeneity in price rigidities is the source of monetary non-neutrality, trend inflation acts to raise the duration of delayed exchange rate overshooting. In a quantitative version of our model, with trend inflation set at historical values, and heterogeneity in price rigidity matched with micro-evidence, the peak response of the nominal and real exchange rates occur over 1 year after a shock to monetary policy, consistent with established empirical estimates.