Retail prices and the real exchange rate

Abstract

This paper uses daily frequency relative prices gathered from online retailers for a basket of countries to investigate the Purchasing Power Parity relationship, exchange rate pass-throughs and the effect of price shocks on nominal exchange rates. We fit a structural VAR model on exchange rate and relative price data to compute impulse responses for each country. We find evidence of exchange rate pass-through for most countries, even at short horizons. Contrary to PPP predictions, we find that most countries witness an exchange rate appreciation post a domestic inflation shock. We study the persistence of each variety of shock and the overall effect on the real exchange rate. We find that real exchange rates are more likely to mean revert if the shock arises from nominal exchange rates as opposed to relative prices.