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Real Exchange Rate Dynamics in the New-Keynesian Model

Kamalyan, Hayk (2021): Real Exchange Rate Dynamics in the New-Keynesian Model.

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Abstract

This paper studies the real exchange rate adjustment process in the baseline small open economy New-Keynesian framework. The paper shows that i)the version of the model with real shocks replicates the persistence and the hump-shaped dynamics of the real exchange rate observed in data ii) the model cannot simultaneously match the observed dynamics of the real exchange rate and the close co-movement between the real and nominal currency returns. Thus, the baseline framework is not capable of fully capturing the real exchange rate adjustment process.

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