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

  • P.J.G. Vlaar

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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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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Web page: http://www.dnb.nl/en/

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  1. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  2. Philip Lane & Gian Maria Milesi-Ferretti, 2001. "Long-Term Capital Movements," CEG Working Papers 20018, Trinity College Dublin, Department of Economics.
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  3. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March.
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  5. Kuttner, Kenneth N, 1994. "Estimating Potential Output as a Latent Variable," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(3), pages 361-68, July.
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  7. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  8. Frank Smets, 2002. "Output gap uncertainty: Does it matter for the Taylor rule?," Empirical Economics, Springer, vol. 27(1), pages 113-129.
  9. Stein, Jerome L. & Allen, Polly Reynolds, 1998. "Fundamental Determinants of Exchange Rates," OUP Catalogue, Oxford University Press, number 9780198293064, March.
  10. Harald Uhlig, 1995. "A toolkit for analyzing nonlinear dynamic stochastic models easily," Discussion Paper / Institute for Empirical Macroeconomics 101, Federal Reserve Bank of Minneapolis.
  11. Maurice Obstfeld, 1985. "Capital Mobility in the World Economy: Theory and Measurement," NBER Working Papers 1692, National Bureau of Economic Research, Inc.
  12. David K. Backus & Patrick J. Kehoe, 1992. "International Evidence on the Historical Properties of Business Cycles," Working Papers 92-5, New York University, Leonard N. Stern School of Business, Department of Economics.
  13. Hans-Werner Sinn & Frank Westermann, 2001. "Why Has the Euro Been Falling?," CESifo Working Paper Series 493, CESifo Group Munich.
  14. Dooley, Michael & Isard, Peter, 1982. "A portfolio-balance rational-expectations model of the dollar-mark exchange rate," Journal of International Economics, Elsevier, vol. 12(3-4), pages 257-276, May.
  15. Giancarlo Corsetti & Paolo Pesenti, 1999. "Stability, Asymmetry, and Discontinuity: The Launch of European Monetary Union," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 30(2), pages 295-372.
  16. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
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