Milton Friedman advocated flexible exchange rates on the premise that they would allow the relative prices of domestic and foreign goods to adjust in a world with nominal rigidities. The strength of his argument, and its implications for monetary and exchange rate policy, depend crucially on the specifics of nominal rigidity: How rigid are prices? Are prices fixed in the producer's currency or in the local currency? When prices adjust, how much do they respond to exchange rate shocks?
The validity of several of the benchmark models and the main hypothesis in international macroeconomics -- such as the Mundell-Fleming models of the 1960s, Dornbusch's overshooting exchange rate hypothesis, and the more recent New Open Economy Macroeconomics literature -- also depend on the answers to these questions. In a series of papers, my co-authors and I shed light on these questions by providing evidence for actual traded goods prices. Using micro-data on U.S. import and export prices at-the-dock for the period 1994 to 2009, we develop theoretical models that provide a better fit for the empirical evidence than earlier theoretical environments.
We document the behavior of trade prices during the Great Trade Collapse of 2008-2009 using transaction-level data from the U.S. Bureau of Labor Statistics. First, we find that differentiated manufactures exhibited marked stability in their trade prices during the large decline in their trade volumes. Prices of non-differentiated manufactures, by contrast, declined sharply. Second, while the trade collapse was much steeper among differentiated durable manufacturers than among non-durables, prices in both categories barely changed. Third, despite this lack of movement in average price levels, the frequency and magnitude of price adjustments at the product level noticeably changed with the onset of the crisis.