Enter the Research Conversation with Petar Dobrev
What determines real exchange rate movements? Can deep habit formation explain real exchange rate movements?
People may form habits over goods and services due to addiction, brand loyalty, social status, etc. If a firm knows that customers form habits with its goods, the firm has incentives to charge lower prices initially. Customers will consume more when prices are low, which will increase their degree of habit formation. Hence, the firm can charge higher prices in the future knowing that its customers are even more “addicted” than before.
The presence of deep habit formation implies that consumers are less responsive to price changes, which has important implications for both the volatility and persistence of the real exchange rate. Hence in a world with habit formation, inflation rates are lower, but with greater volatility in the real exchange rate.
Area of Research
Real Exchange Rate Movements
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