DP2944 Distribution Costs and Real Exchange Rate Dynamics During Exchange-Rate-Based Stabilization

Author(s): Ariel Tomas Burstein , Joao C Neves , Sérgio Rebelo

Publication Date: September 2001

Keyword(s): Real exchange rate , distribution , inflation , stabilization , fixed exchange rates

JEL(s): F41

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP2944.asp

This Paper studies the role played by distribution costs in shaping the behaviour of the real exchange rate during exchange-rate-based stabilizations. We document that distribution costs are very large for the average consumer good: the represent more than 40% of the retail price in the US and 60% of the retail price in Argentina. Distribution services require local labour and so so they drive a natural wedge between retail prices in different countries. We show that introducing a distribution sector in an otherwise standard model of exchange-rate-based stabilizations dramatically improves its ability to rationalise observed real exchange rate dynamics.