Large Devaluations and the Real Exchange Rate∗

In this paper we argue that the primary force behind the large drop in real exchange rates that occurs after large devaluations is the slow adjustment in the price of nontradable goods and services. Our empirical analysis uses data from five large devaluation episodes: Argentina (2001), Brazil (1999), Korea (1997), Mexico (1994), and Thailand (1997). We conduct a detailed analysis of the Argentina case using disaggregated CPI data, data from our own survey of prices in Buenos Aires, and scanner data from supermarkets. We assess the robustness of our findings by studying large real-exchange-rate appreciations, medium devaluations, and small exchange-rate movements. J.E.L. Classification: F31 ∗We thank Kei-Mu Yi for sharing data on input-output tables with us, Federico Ganduglia and Martin Cortes for assistance in collecting prices in Argentina, and Etienne Gagnon, Herman Kamil, and Yossi Yakhin for research assistance. We also thank Pierpaolo Benigno, Mario Crucini, Beverly Lapham, and Andy Neumeyer for their comments. Finally, we benefited from detailed comments from Fernando Alvarez and four anonymous referees. We gratefully acknowledge financial support from the National Science Foundation. †UCLA. ‡Northwestern University, NBER and Federal Reserve of Chicago. §Northwestern University, NBER and CEPR.