Comment

Abstract

Exchange rates have exasperated economists for some time. Lucasz Drozd and Jaromir Nosal dissect movements in bilateral real consumption exchange rates into their traded and nontraded components for a broad set of country pairs. They first divide each country i’s goods into those that are traded, T, and those that are nontraded,N, with respective price indices Pi and P T i , which combine into the overall price index, as given in their equation (3), with ζ the share of nontraded goods. The deflator‐based real exchange rate between country i and j, rerij, their equation (4), relates the overall price indices of two different countries, Pi and Pj, translating country j’s price index into country i’s currency at the nominal exchange rate eij. They then decompose rerij into its traded goods component rerij , their equation (5), and the nontradable real exchange rate rerN ij , their equation (6). The first is simply the ratio of the two countries’ traded price indiceswith country j’s translated into i’s currency at the nominal exchange rate eij. The second is the ratio of the ratios of the nontraded to traded price indices of the two countries. Thus, their equation (7):