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How Important are Nominal Shocks in Driving Real Exchange Rates?

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  • Bernd Kempa

    ()
    (Universitaet Duisburg-Essen)

Abstract

Most of the extant literature identifies the sources of real exchange rate fluctuations by means of structural VAR analysis using long-run identification restrictions only. This paper presents an analogous decompositon on the basis of a simple textbook model of exchange rate determination, where identification is achieved after a suitable triangularization. This identification strategy allows for a calibration on the basis of the contemporaneous restrictions implied by the model. In order to facilitate a comparison with the results form the structural VAR stuies, very similar data are used here as well. These ar quarterly data collected on the bilateral exchange rates for the Deutsche Mark, the British Pound and the Japanese Yen, all relative to the U.S. Dollar. The implied impulse response functions of the model exhibit impact reactions of the exchange rate following either a monetary (nominal) or a real shock, thus conforming to the asset price property of exchange rates. This is in contrast to the delayed exchange rate responses typical in the structural VAR studies. Moreover, The variance decompositions indicate a dominant role for real shocks, with nominal shocks recognizable at best only in the short run. These results correspond quite closely to those obtained from structural VARs.

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Bibliographic Info

Article provided by Justus-Liebig University Giessen, Department of Statistics and Economics in its journal Journal of Economics and Statistics.

Volume (Year): 225 (2005)
Issue (Month): 2 (March)
Pages: 192-204

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Handle: RePEc:jns:jbstat:v:225:y:2005:i:2:p:192-204

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Keywords: Nominal and real shocks; exchange rate variability; VAR;

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References

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  1. Jon Faust & Eric M. Leeper, 1994. "When do long-run identifying restrictions give reliable results?," Working Paper 94-2, Federal Reserve Bank of Atlanta.
  2. Blanchard, Olivier Jean & Quah, Danny, 1989. "The Dynamic Effects of Aggregate Demand and Supply Disturbances," American Economic Review, American Economic Association, vol. 79(4), pages 655-73, September.
  3. Lastrapes, William D, 1992. "Sources of Fluctuations in Real and Nominal Exchange Rates," The Review of Economics and Statistics, MIT Press, vol. 74(3), pages 530-39, August.
  4. Goldstein, Morris & Khan, Mohsin S., 1985. "Income and price effects in foreign trade," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 20, pages 1041-1105 Elsevier.
  5. John H. Rogers, 1998. "Monetary shocks and real exchange rates," International Finance Discussion Papers 612, Board of Governors of the Federal Reserve System (U.S.).
  6. Clarida, R. & Gali, J., 1993. "Sources of Real Exchange Rate Fluctuations: How Important are Nominal Shocks?," Discussion Papers 1993_25, Columbia University, Department of Economics.
  7. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  8. Weber, Axel A., 1997. "Sources of Purchasing Power Disparities Between the G3-Economies," Discussion Paper Serie B 419, University of Bonn, Germany.
  9. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March.
  10. Stockman, Alan C, 1980. "A Theory of Exchange Rate Determination," Journal of Political Economy, University of Chicago Press, vol. 88(4), pages 673-98, August.
  11. Mussa, Michael, 1982. "A Model of Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 74-104, February.
  12. Weber, Axel A., 1997. "Sources of Purchasing Power Disparities between the G3 Economies," Journal of the Japanese and International Economies, Elsevier, vol. 11(4), pages 548-583, December.
  13. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
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