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Marginal Utility and International Relative Prices

A wide range of international macroeconomic models link the real exchange rate to a ratio of marginal utilities. These include models based on non-traded goods or those with a variety of frictions including trading costs and pricing to market. Empirical work has found little evidence of this link. We augment the measurement of international relative prices to allow for incomplete pass-through of nominal exchange rate changes to domestic inflation. With that realistic feature, there is a clear connection between relative prices and relative marginal utilities in a panel of OECD countries since 1960. Preference parameters are significant and consistent with theory.