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On the Strength 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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File URL: http://www.dnb.nl/binaries/wo0668_tcm46-145970.pdf
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Paper provided by Netherlands Central Bank, Research Department in its series WO Research Memoranda (discontinued) with number 668.

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Date of creation: 2001
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Handle: RePEc:dnb:wormem:668
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Web page: http://www.dnb.nl/en/

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  12. 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.
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