Three essays on dynamics of real exchange rate

Understanding the dynamics of the real exchange rate is one of challenging tasks in open economy macroeconomics. When it is believed that in the sticky price framework, the main source of the persistence of the real exchange rate is the relative price across countries, explanation of its observed persistence has not been much successful. When evaluating open economy monetary policy, it is crucial to understand its observed short run movement which has not been modeled well in monetary policy models.;The first chapter studies the effect of habit formation in consumption on the real exchange persistence under monetary policy shocks. I show that the habit formation effect depends on the assumption of the degree of price stickiness as well as on the design of the monetary policy rule, but habit formation does not contribute to the persistence of the real exchange rate in a significant way.;The second chapter investigates nonlinear behavior of the real exchange rate by using a Threshold Vector Error Correction Model of its two components, the nominal exchange rate and the relative price. The surprising finding is that their correction roles are distinct between outside and inside a band relative to those in the linear framework. That is, it is only outside the band that the nominal exchange rate makes its significant contribution to the correction of deviation from PPP and it is the relative price that corrects deviation from PPP within the band, if the correction is indeed made within the band.;The third chapter performs the welfare-based policy evaluation of real exchange rate stabilization in the presence of news shocks about the future technology level. In the sticky price economy, I show that the optimal policy rule requires real exchange rate stabilization. In the economy with both sticky wages and prices, the inflation-targeting policy alone amplifies the response of the economy to news shocks. In this case, either real exchange rate or output gap stabilization is needed to prevent the economy from overreacting to news shocks. As long as there is operationality issue with output gap stabilization, however, real exchange rate stabilization is needed.