Real exchange rate movements in high inflation countries
We empirically assess the sources of fluctuations in the real exchange rates of four high inflation countries, for which monetary shocks are generally believed to be predominant. In a benchmark model we identify fiscal, monetary, and output shocks based on a general-equilibrium optimizing model. We then estimate two alternative extensions. In the first, we decompose the output shock into supply and demand disturbances; in the second, the monetary shock is further decomposed into money supply and nominal exchange rate disturbances. Monetary shocks are found to be generally significant. Real shocks, especially those associated with government policy restrictions on the flow of currency, income from foreign investments, capital, and/or goods, are uniformly more influential however. The paper suggests that analyses of real exchange rates in high inflation economies using models emphasizing monetary shocks and sticky prices could be improved by not negtecting real shocks.
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