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Cointegration and the stabilizing role of exchange rates

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Author Info

  • Alexius, Annika

    (Department of Economics)

  • Post, Erik

    ()
    (Department of Economics)

Abstract

We show that empirical results concerning the behavior of floating exchange rates differ between otherwise identical cointegrated and non-cointegrated VAR models. In particular, virtually all ten-year movements in nominal exchange rates are due to fundamental supply and demand shocks when long run equilibrium relationships between the levels of the variables are included in the empirical specification. Another major difference between the models with the opposite implication for the shock creation versus shock absorption debate is that non-fundamental exchange rate shocks have much larger effects on output and inflation in the cointegrated models. Finally, impulse response functions in the first difference specification die out within a year whereas adjustment to long run equilibrium continues for up to ten years in the cointegrated models. Hence a correct specification of the long-run equilibrium dynamics of exchange rates is essential for capturing also short-run behavior of exchange rates.

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Bibliographic Info

Paper provided by Uppsala University, Department of Economics in its series Working Paper Series with number 2006:8.

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Length: 33 pages
Date of creation: Feb 2006
Date of revision:
Handle: RePEc:hhs:uunewp:2006_008

Contact details of provider:
Postal: Department of Economics, Uppsala University, P. O. Box 513, SE-751 20 Uppsala, Sweden
Phone: + 46 18 471 25 00
Fax: + 46 18 471 14 78
Email:
Web page: http://www.nek.uu.se/
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Keywords: Exchange rates; asymmetric shocks; structural VAR; cointegration;

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References

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  1. Alexius, Annika & Carlsson, Mikael, 2002. "Measures of Technology and the Business Cycle," Working Paper Series 2002:10, Uppsala University, Department of Economics, revised 02 Mar 2006.
  2. Strauss, Jack, 1996. "The cointegrating relationship between productivity, real exchange rates and purchasing power parity," Journal of Macroeconomics, Elsevier, vol. 18(2), pages 299-313.
  3. Maurice Obstfeld and Kenneth Rogoff., 2000. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," Center for International and Development Economics Research (CIDER) Working Papers C00-112, University of California at Berkeley.
  4. Hilde Bjørnland, 2004. "The Role of the Exchange Rate as a Shock Absorber in a Small Open Economy," Open Economies Review, Springer, vol. 15(1), pages 23-43, January.
  5. Groen, Jan J J, 2005. "Exchange Rate Predictability and Monetary Fundamentals in a Small Multi-country Panel," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(3), pages 495-516, June.
  6. Dutton, Marilyn & Strauss, Jack, 1997. "Cointegration tests of purchasing power parity: the impact of non-traded goods," Journal of International Money and Finance, Elsevier, vol. 16(3), pages 433-444, June.
  7. Joyce, J.P. & Kamas, L., 1997. "Real and Nominal Determinants of Real Exchange Rates in Latin America: Short-Run Dynamics and Long-Run Equilibrium," Papers 97-05, Wellesley College - Department of Economics.
  8. Artis, Michael J & Ehrmann, Michael, 2000. "The Exchange Rate - A Shock-Absorber or Source of Shocks? A Study of Four Open Economies," CEPR Discussion Papers 2550, C.E.P.R. Discussion Papers.
  9. Tor Jacobson & Per Jansson & Anders Vredin & Anders Warne, 2001. "Monetary policy analysis and inflation targeting in a small open economy: a VAR approach," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 16(4), pages 487-520.
  10. Alexius, Annika, 2005. "Productivity shocks and real exchange rates," Journal of Monetary Economics, Elsevier, vol. 52(3), pages 555-566, April.
  11. Alexius, Annika & Post, Erik, 2005. "Exchange Rates and Asymmetric Shocks in Small Open Economies," Working Paper Series 2005:10, Uppsala University, Department of Economics.
  12. Duarte, Margarida, 2003. "Why don't macroeconomic quantities respond to exchange rate variability?," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 889-913, May.
  13. Menzie David Chinn, 1997. "Sectoral Productivity, Government Spending and Real Exchange Rates: Empirical Evidence for OECD Countries," NBER Working Papers 6017, National Bureau of Economic Research, Inc.
  14. Louis Kuijs & Alain Borghijs, 2004. "Exchange Rates in Central Europe: a Blessing or a Curse?," IMF Working Papers 04/2, International Monetary Fund.
  15. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
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Citations

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Cited by:
  1. Blomquist, Sören & Christiansen, Vidar, 2007. "Public Provision of Private Goods and Nondistortionary Marginal Tax Rates," Working Paper Series 2007:7, Uppsala University, Department of Economics.
  2. Ågren, Martin, 2006. "Prospect Theory and Higher Moments," Working Paper Series 2006:24, Uppsala University, Department of Economics.
  3. Per Engstrom & Bertil Holmlund, 2009. "Tax evasion and self-employment in a high-tax country: evidence from Sweden," Applied Economics, Taylor & Francis Journals, vol. 41(19), pages 2419-2430.
  4. Hallberg, Daniel, 2006. "Cross-national differences in income poverty among Europe´s 50+," Working Paper Series 2006:14, Uppsala University, Department of Economics.

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