The Real Exchange Rate And Real Interest Differentials: The Role Of The Trend-Cycle Decomposition
We propose an alternative model and method to reconcile the puzzling feature in the relationship between the real exchange rate and real interest rate differentials. Our simple two-country model with preset prices, along with firms’ misperception about the future exchange rate, implies that the real exchange rate follows an ARIMA(0,1,p) process. This allows us to compute the exact Beveridge-Nelson decomposition, which is a model-consistent decomposition. In accordance with our model, unit roots in the real exchange rates are found; and statistical inference is partially found to be affirmative regarding the link between the real exchange rate detrended by the Beveridge-Nelson decomposition and corresponding real interest differentials.
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Volume (Year): 50 (2012)
Issue (Month): 4 (October)
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- Asea, Patrick K & Reinhart, Carmen M, 1996.
"Le Prix de l'Argent: How (Not) to Deal with Capital Inflows,"
Journal of African Economies,
Centre for the Study of African Economies (CSAE), vol. 5(3), pages 231-271, October.
- Asea, Patrick K & Reinhart, Carmen M, 1996. "Economic Growth and Economic Consequences of External Shocks in Sub-Saharan Africa: Introduction," Journal of African Economies, Centre for the Study of African Economies (CSAE), vol. 5(3), pages 1-6, October.
- Reinhart, Carmen & Asea, Patrick, 1995. "Real interest rate differentials and the real exchange rate: Evidence from four African countries," MPRA Paper 13357, University Library of Munich, Germany.
- Morley, James C., 2002. "A state-space approach to calculating the Beveridge-Nelson decomposition," Economics Letters, Elsevier, vol. 75(1), pages 123-127, March. Full references (including those not matched with items on IDEAS)
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