Do Policy-Related Shocks Affect Real Exchange Rates? An Empirical Analysis Using Sign Restrictions and a Penalty-Function Approach
AbstractWe examine the response of real exchange rates to shocks in real exchange rate determinants, a monetary policy shock, and a fiscal policy shock in 30 countries over the period 1970-2008. The country set is divided into 4 groups - European, developed-country, Asian developing-country, and non Asian developing-country groups. We propose and apply a new approach, i.e. we employ a panel Bayesian structural vector error correction model, and we impose sign restrictions with a penalty-function approach to identify the shocks. We find that most of our impulse response analysis is in line with economic theories. Specifically, there is strong evidence that trade liberalization generates a real depreciation and an increase in government spending leads to a real appreciation over the long run. We also find that a contractionary monetary policy shock has only short-run impacts on real exchange rates, corresponding to the long-run neutrality of monetary policy. The responses to a productivity shock are interesting, i.e. productivity growth in traded sectors has no effect on the real exchange rate of the Asian developing-country group, and it leads to a long-run real appreciation in the non Asian developing-country group. In contrast, this shock causes a real depreciation in the European country group over the long run. Variance decomposition suggests that international trade policy contributes the most to real exchange rate movements in most country groups, with the exception of the non Asian developing-country group, for which fiscal policy via government spending seems to be the most important.
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Bibliographic InfoPaper provided by Monash University, Department of Econometrics and Business Statistics in its series Monash Econometrics and Business Statistics Working Papers with number 25/11.
Length: 77 pages
Date of creation: 10 Nov 2011
Date of revision:
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Postal: PO Box 11E, Monash University, Victoria 3800, Australia
Web page: http://www.buseco.monash.edu.au/depts/ebs/
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Find related papers by JEL classification:
- C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Longitudinal Data; Spatial Time Series
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- F31 - International Economics - - International Finance - - - Foreign Exchange
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-11-28 (All new papers)
- NEP-CBA-2011-11-28 (Central Banking)
- NEP-MON-2011-11-28 (Monetary Economics)
- NEP-OPM-2011-11-28 (Open Economy Macroeconomic)
- NEP-SEA-2011-11-28 (South East Asia)
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