Maintaining price stability: how long is the medium term?

This paper studies the role played by distribution costs in shaping the behavior of the real exchange rate during exchange-ratebased stabilizations. We document that distribution costs are very large for the average consumer good: they represent more than 40% of the retail price in the US and roughly 60% of the retail price in Argentina. Distribution services require local labor and land so they drive a natural wedge between retail prices in different countries. We show that introducing a distribution sector in an otherwise standard model of exchange-rate-based stabilizations dramatically improves its ability to rationalize observed real exchange rate dynamics.