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On the indirect causality relation from exchange rates to fundamentals

Author

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  • Hsiu-Hsin Ko

    () (National University of Kaohsiung)

Abstract

In this study, we examine whether the monetary-transmission mechanism of exchange rate changes also explains the finding of the causality relation from exchange rates to fundamentals, which is taken as a validation for the present value model for exchange rates in a prominent work. To take account of the indirect causality relation between variables implied by the monetary-transmission mechanism, we apply the method proposed by Dufour and Taamouti (2010) to estimate the causality and perform the test. We observe that the causality relation from exchanger rates to UIP and PPP fundamentals could be stronger in the middle horizon than the short and long horizon, which implies the exchange rate change has inertial effect on the fundamentals. However, the effect is not statistically significant, which implies that the role of the exchange rate may not be so important as to influence the monetary policy rule.

Suggested Citation

  • Hsiu-Hsin Ko, 2015. "On the indirect causality relation from exchange rates to fundamentals," Economics Bulletin, AccessEcon, vol. 35(3), pages 1518-1524.
  • Handle: RePEc:ebl:ecbull:eb-15-00152
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    References listed on IDEAS

    as
    1. Charles Engel & Kenneth D. West, 2005. "Exchange Rates and Fundamentals," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 485-517, June.
    2. Dufour, Jean-Marie & Pelletier, Denis & Renault, Eric, 2006. "Short run and long run causality in time series: inference," Journal of Econometrics, Elsevier, vol. 132(2), pages 337-362, June.
    3. Dufour, Jean-Marie & Taamouti, Abderrahim, 2010. "Short and long run causality measures: Theory and inference," Journal of Econometrics, Elsevier, vol. 154(1), pages 42-58, January.
    4. Jean-Marie Dufour & Eric Renault, 1998. "Short Run and Long Run Causality in Time Series: Theory," Econometrica, Econometric Society, vol. 66(5), pages 1099-1126, September.
    5. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
    6. John B. Taylor, 2001. "The Role of the Exchange Rate in Monetary-Policy Rules," American Economic Review, American Economic Association, vol. 91(2), pages 263-267, May.
    7. Granger, C W J, 1969. "Investigating Causal Relations by Econometric Models and Cross-Spectral Methods," Econometrica, Econometric Society, vol. 37(3), pages 424-438, July.
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    More about this item

    Keywords

    exchange rates; fundamentals; causality relation; inertial effects of exchange-rate transmission;

    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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