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Explaining Real Exchange Rates Fluctuations

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    Abstract

    This paper attempts to explain the sources of real exchange rate fluctuations for a set of advanced economies and Central and Eastern European transition economies. To address this, firstly, we compute two measures of the share of the variance in the real exchange rate accounting for movements in the relative prices of traded goods between countries. Secondly, we estimate structural (identified) vector autoregression (SVAR) models, and decompose real and nominal exchange rate movements into those caused by real and nominal shocks. Thirdly, we complete the previous steps with an impulse-response analysis. The results suggest that: (1) for transition economies, under regimes of managed nominal exchange rates, the relative price of non-traded goods explains a large percentage of the variance in the real exchange rate; (2) there is evidence of instability in the variance decomposition of real exchange rates for advanced economies across samples; and (3) as result of diverse fiscal and monetary policies in transition economies, real exchange rates in some economies are driven mostly by real shocks while in others they are driven mostly by nominal shocks.

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    Paper provided by Centro de Estudios Andaluces in its series Economic Working Papers at Centro de Estudios Andaluces with number E2004/23.

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    Length: 22 pages
    Date of creation: 2004
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    Handle: RePEc:cea:doctra:e2004_23

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    Keywords: real exchange rate; nominal exchange rate; real shocks; nominal shocks; SVAR models; advanced economies; transition economies.;

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    1. Rogers, J.H. & Jenkins, M.A., 1993. "Haircuts or Hysteresis? Sources of Movements in Real Exchange Rates," Papers, Pennsylvania State - Department of Economics 4-93-6, Pennsylvania State - Department of Economics.
    2. Olivier Jean Blanchard & Danny Quah, 1988. "The Dynamic Effects of Aggregate Demand and Supply Disturbance," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 497, Massachusetts Institute of Technology (MIT), Department of Economics.
    3. International Monetary Fund, 2001. "Interpreting Real Exchange Rate Movements in Transition Countries," IMF Working Papers, International Monetary Fund 01/56, International Monetary Fund.
    4. Dibooglu, Selahattin & Kutan, Ali M., 2000. "Sources of real exchange rate fluctuations in transition economies: The case of Ploand and Hungary," ZEI Working Papers B 14-2000, ZEI - Center for European Integration Studies, University of Bonn.
    5. Charles Engel & John H. Rogers, 1999. "Violating the law of one price: should we make a federal case out of it?," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 644, Board of Governors of the Federal Reserve System (U.S.).
    6. 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.
    7. Engel, Charles, 1993. "Real exchange rates and relative prices : An empirical investigation," Journal of Monetary Economics, Elsevier, Elsevier, vol. 32(1), pages 35-50, August.
    8. Desai, Padma, 1998. "Macroeconomic Fragility and Exchange Rate Vulnerability: A Cautionary Record of Transition Economies," Journal of Comparative Economics, Elsevier, vol. 26(4), pages 621-641, December.
    9. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, Econometric Society, vol. 59(6), pages 1551-80, November.
    10. László Halpern & Charles Wyplosz, 1997. "Equilibrium Exchange Rates in Transition Economies," IMF Staff Papers, Palgrave Macmillan, vol. 44(4), pages 430-461, December.
    11. Enders, Walter & Lee, Bong-Soo, 1997. "Accounting for real and nominal exchange rate movements in the post-Bretton Woods period," Journal of International Money and Finance, Elsevier, Elsevier, vol. 16(2), pages 233-254, April.
    12. Brada, Josef C., 1998. "Introduction: Exchange Rates, Capital Flows, and Commercial Policies in Transition Economies," Journal of Comparative Economics, Elsevier, vol. 26(4), pages 613-620, December.
    13. Engel, C., 1996. "Accounting for U.S. Real Exchange Rate Changes," Discussion Papers in Economics at the University of Washington, Department of Economics at the University of Washington 96-02, Department of Economics at the University of Washington.
    14. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(6), pages 1161-76, December.
    15. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 12(2-3), pages 231-254.
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