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Supply Shocks and Real Exchange Rate Dynamics: Canadian Evidence

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Celine Gauthier
David Tessier
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File URL: http://www.bankofcanada.ca/en/res/wp/2002/wp02-31.pdf
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Paper provided by Bank of Canada in its series Working Papers with number 02-31.

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Length: 30 pages Abstract: In this paper, we study the impact of supply shocks on the Canadian real exchange rate. We specify a structural vector-error-correction model that links the real exchange rate to different fundamentals. The identification scheme we use to recover the different shocks is based on long-run restrictions and allows us to decompose the real exchange rate according to different long-run trends, basically defined in terms of permanent shocks. Two main results emerge from our analysis. First, a positive supply shock in favour of Canada leads to a real exchange rate appreciation. Although consistent with the Balassa-Samuelson hypothesis, this result contradicts previous findings that have used a similar methodology. Second, commodity price shocks tend to dominate exchange rate movements over the short and medium run, but supply shocks have the largest impact over the long run. In particular, supply shocks explain most of the stochastic depreciation of the Canadian real exchange rate since the beginning of the 1990s.
Date of creation: 2002
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Handle: RePEc:bca:bocawp:02-31

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Keywords: Exchange Rates;

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Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions

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References listed on IDEAS
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  22. Baxter, Marianne, 1994. "Real exchange rates and real interest differentials: Have we missed the business-cycle relationship?," Journal of Monetary Economics, Elsevier, vol. 33(1), pages 5-37, February. [Downloadable!] (restricted)
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  28. Kenneth Rogoff & Yu-chin Chen, 2002. "Commodity Currencies and Empirical Exchange Rate Puzzles," IMF Working Papers 02/27, International Monetary Fund.
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  1. Céline Gauthier & Fu Chun Li, 2006. "Linking Real Activity and Financial Markets: The Bonds, Equity, and Money (BEAM) Model," Working Papers 06-42, Bank of Canada. [Downloadable!]
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