The Journal of Political Economy has announced the winners of this year's Robert E. Lucas Jr. Prize: Oleg Itskhoki and Dmitry Mukhin for "Exchange Rate Disconnect in General Equilibrium"  (Journal of Political Economy 129 [8]: 2183-2232).

Papers published between July 2020 and June 2022 were considered for this, the fourth prize.

The following description of the winning paper was originally published on the Journal of Political Economy website.

"Itskhoki and Mukhin develop a general equilibrium model of exchange rate determination, which offers a unifying resolution to a range of outstanding emprical puzzles in international macroeconomics. The puzzles the paper addresses all pertain to 'exchange rate disconnect': the observation that despite substantial business cycle co-movement in real variables across countries, and although exchange rates are the main prices in international markets, there is very little correlation between exchange rates and other macro variables. Exchange rate disconnect is at the heart of the puzzles this paper tackles: (i) the Meese-Rogoff (1993) puzzle, (ii) the PPP puzzle (Rogoff (1996)), (iii) the LOP/Terms-of-Trade puzzle (Engel 1999, Atkeson-Burstein 2008), (iv) the Backus-Smith (1993) puzzle, and (v) the forward-premium puzzle (Fama 1984).

The exogenous shocks in Itskhoki and Mukhin's theory originate in financial markets. They posit an imperfect financial market with noise traders in which international transactions are mediated through risk-averse arbitrageurs. They show that when combined with home bias in the product market, persistent demand shocks in the financial market are the only type of shock that can qualitatively generate the patterns of co-movement implied by the aforementioned puzzles. They go on to show how various additional frictions that lead to incomplete pass-through, including pricing to market and foreign currency price stickiness, can improve the quantitative fit of the model. Overall, this paper succeeds where the existing literature has failed. Through a combination of theoretical and empirical work, Itskhoki and Mukhin have greatly advanced our understanding of exchange rate dynamics."

The Lucas Prize is awarded biannually for the most interesting paper in the area of Dynamic Economics published in the Journal of Political Economy in the preceding two years. The prize was established in 2016 on the occasion of the celebration of Lucas’s seminal contributions to economics and his Phoenix Prize award.

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