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Multilateral Adjustment and Exchange Rate Dynamics: The Case of Three Commodity Currencies

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Author Info

  • Jeannine Bailliu
  • Ali Dib
  • Takashi Kano
  • Lawrence Schembri

Abstract

In this paper, we empirically investigate whether multilateral adjustment to large U.S. external imbalances can help explain movements in the bilateral exchange rates of three commodity currencies -- the Australian, Canadian and New Zealand (ACNZ) dollars. To examine the relationship between exchange rates and multilateral adjustment, we develop a new regimeswitching model that augments a standard Markov-switching framework with a threshold variable. This enables us to model the exchange rate dynamics of our commodity currencies in the context of two regimes: one in which multilateral adjustment to large U.S. external imbalances is an important factor driving the commodity currencies and the second in which there are no significant U.S. external imbalances and hence multilateral adjustment is not a factor. We compare the performance of this model, both in and out-of-sample, to several other alternative models. In addition to developing this new model, another distinguishing feature of our paper is that we estimate all of our models using a Bayesian approach. We opt for a Bayesian approach in this context because it provides a simpler and more intuitive means of evaluating and comparing our different non-nested models. Moreover, it is relatively straightforward using a Bayesian approach to evaluate the importance of nonlinearities in the relationship between exchange rates and multilateral adjustment. Our findings suggest that during periods of large U.S. imbalances, fiscal and external, an exchange rate model for the ACNZ dollars should allow for multilateral adjustment effects. Moreover, we also find evidence to suggest that the adjustment of exchange rates to multilateral adjustment factors is best modelled as a non-linear process.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 07-41.

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Length: 71 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:bca:bocawp:07-41

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Related research

Keywords: Exchange rates; Econometric and statistical methods;

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Cited by:
  1. Maxym Chaban, 2010. "Cointegration analysis with structural breaks and deterministic trends: an application to the Canadian dollar," Applied Economics, Taylor & Francis Journals, vol. 42(23), pages 3023-3037.
  2. Bailliu, Jeannine & Dib, Ali & Kano, Takashi & Schembri, Lawrence, 2014. "Multilateral adjustment, regime switching and real exchange rate dynamics," The North American Journal of Economics and Finance, Elsevier, vol. 27(C), pages 68-87.
  3. Balázs Égert, 2012. "Nominal and Real Exchange Rate Models in South Africa: How Robust Are They?," EconomiX Working Papers 2012-18, University of Paris West - Nanterre la Défense, EconomiX.
  4. Balazs Egert, 2009. "The Impact of Monetary and Commodity Fundamentals, Macro News and Central Bank Communication on the Exchange Rate: Evidence from South Africa," William Davidson Institute Working Papers Series wp955, William Davidson Institute at the University of Michigan.
  5. Maral Kichian & Ali Dib & Carlos de Resende, 2010. "Optimized Monetary Policy Rules in Multi-Sector Small Open Economies: The Role of Real Rigidities," 2010 Meeting Papers 184, Society for Economic Dynamics.

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