The Nontradable Goods' Real Exchange Rate Puzzle

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The paper studies empirically and theoretically the decomposition of the real exchange rates into tradable and nontradable components, in the spirit of Charles Engel. Empirically, we find that the contribution of the nontradable component is at best modest—confirming the results from the literature. Theoretically, we establish that this finding is a puzzle for the standard models in which the fluctuations of the tradable component are driven by the relative price movements of differentiated home and foreign tradable goods, and the law of one price holds.