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On the Strenght of the US Dollar: Can it be Explained by Output Growth?

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  • P.J.G. Vlaar

Abstract

One popular view on the current strength of the US dollar is that the higher growth in the US compared to Europe has stimulated foreigners to buy American assets, thereby driving up the exchange rate. In this paper a modified portfolio balance model is presented, in which it is shown that the impact of output growth on the exchange rate depends crucially on the origin of this growth. An improvement of the output gap is shown to actually depress the exchange rate whereas an increase in potential output growth leads to an appreciation, especially if this improvement is likely to be persistent. In an empirical example, it is shown that the equilibrium Dmark dollar rate is indeed positively affected by a positive trend growth differential between the US and Germany, whereas it is negatively affected by a positive output gap differential.

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Bibliographic Info

Paper provided by Netherlands Central Bank in its series DNB Staff Reports (discontinued) with number 82.

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Date of creation: 2003
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Handle: RePEc:dnb:staffs:82

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Keywords: rational expectations; portfolio balance model; Taylor rule; Kalman filter; foreign direct in- vestment;

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  1. Frank Smets, 2002. "Output gap uncertainty: Does it matter for the Taylor rule?," Empirical Economics, Springer, vol. 27(1), pages 113-129.
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Cited by:
  1. Pompeo Della Posta, 2005. "Fundamentals, International Role of Euro and 'Framing' of Expectations: What are the Determinants of the Dollar/Euro Exchange Rate?," Working Papers de Economia (Economics Working Papers) 24, Departamento de Economia, Gestão e Engenharia Industrial, Universidade de Aveiro.
  2. Jeffery D. Amato & Andrew Filardo & Gabriele Galati & Goetz von Peter & Feng Zhu, 2005. "Research on exchange rates and monetary policy: an overview," BIS Working Papers 178, Bank for International Settlements.
  3. Helmut Frisch, 2003. "The euro and its consequences: What makes a currency strong?," Atlantic Economic Journal, International Atlantic Economic Society, vol. 31(1), pages 15-31, March.

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