Understanding the Effect of Productivity Changes on International Relative Prices: The Role of News Shocks

Abstract

The terms of trade and the real exchange rate of the US appreciate when the US labor productivity increases relative to the rest of the world. This finding is at odds with predictions from standard international macroeconomic models. In this paper, we find that incorporating news shocks to total factor productivity (TFP) in an otherwise standard dynamic stochastic general equilibrium (DSGE) model with variable capital utilization can help the model replicate the above empirical finding. Labor productivity increases in our model after a positive news shock to TFP because of an increase in capital utilization. Under some plausible calibrations, the wealth effect of good news about future productivity can increase domestic demand strongly and induce an increase in home prices relative to foreign prices.

The effects of surprise and anticipated technology changes on international relative prices and trade

“…As in Barsky and Sims (2011), our measure of US TFP is the US quarterly factor-utilization-adjusted TFP series provided in Fernald (2009 Nam and Wang (2010a) show in their theoretical models that capital utilization changes immediately in response to news TFP shocks.…”

The consumption-real exchange rate anomaly with extensive margins

“…This creates a short-run terms of trade appreciation under high trade elasticity. The resolution of the puzzle relying on this latter mechanism is also explored in Opazo (2006) and Nam and Wang (2010).…”

The Effects of News About Future Productivity on International Relative Prices: An Empirical Investigation

“…We then study the effects of news and contemporaneous shocks to productivity on the US real exchange rate and the relative importance of these two shocks in driving the US real exchange rate at different horizons. Findings in this paper can help us evaluate the empirical relevance of news shocks to TFP in Nam and Wang (2010) as an explanation of the discrepancy documented in studies of the international transmission of productivity shocks. In addition, they can shed some light on the importance of news shocks in modeling exchange rate volatility.…”

“…In a model with both internal and external margins of international trade, they show that the second type of productivity gains can improve the terms of trade while the first type deteriorates the terms of trade. Nam and Wang (2010) explore the role of news about future total factor productivity (TFP) in driving international relative prices. An important feature of the news shock is its impact on present variables through the wealth effect.…”

“…When consumption is biased towards home goods, the increase in aggregate consumption falls disproportionately on home goods, therefore raising home goods prices relative to foreign goods prices. In a dynamic stochastic general equilibrium (DSGE) model modified with news shocks to TFP and variable capital utilization, Nam and Wang (2010) show that the terms of trade and the real exchange rate appreciate and labor productivity increases following a positive news shock. The appreciation of the terms of trade is due to the wealth effect described above and the increase in labor productivity is due to the increase in capital utilization following good news about future productivity.…”