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Macroeconomic Determinants of Real Exchange Rates

Listed author(s):
  • William H. Branson

This paper presents a model that integrates money, relative prices, and the current account balance as factors explaining movements in nominal (effective) exchange rates. Thus money and the current account are the proximate determinants of changes in real (effective) rates. The basic model is first analyzed under static expectations. It is an extension of Branson (1977) to include explicitly exogenous disturbances to the current account. Next, rational expectations are introduced, and it is shown that the nominal (and real) rate should be expected to jump instantaneously in response to new information or "innovations" in money, the current account, and relative prices. The model is applied to the quarterly data on effective exchange rates, relative prices, money and the current account for four countries--the U.S., the U.K., Germany and Japan -- since 1973. First the time-series properties of the data are described. All are approximately first-order autocorrelations except all relative prices and Japan's effective exchange rate and current account balance. These are second-order autocorrelations. Then vector autoregressions (VARs) are estimated among the four variables for each country. The residuals from these equations are the "innovations" in the data -- the current movements not predicted by the past. The correlations amongst these innovations are consistent with the theory. Thus the broad conclusion from the paper is that the theoretical model which integrates money, the balance on current account and relative prices, is consistent with movements in these variables since 1973. Real exchange rates adjust to real disturbances in the current account, and time-series innovations in the current account seem to signal the need for adjustment.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0801.

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Date of creation: Nov 1981
Publication status: published as Branson, William H. "Macroeconomic Determinants of Real Exchange Rates." Managing Foreign Exchange Risk, edited by R. J. Herring,Cambridge: Cambridge University Press, 1983.
Handle: RePEc:nbr:nberwo:0801
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  1. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  2. Rudiger Dornbusch, 1980. "Exchange Rate Economics: Where Do We Stand?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(1, Tenth ), pages 143-206.
  3. Taylor, John B., 1980. "Output and price stability: An international comparison," Journal of Economic Dynamics and Control, Elsevier, vol. 2(1), pages 109-132, May.
  4. Branson, William H. & Halttunen, Hannu & Masson, Paul, 1977. "Exchange rates in the short run: The dollar-dentschemark rate," European Economic Review, Elsevier, vol. 10(3), pages 303-324.
  5. William H. Branson & Herbert Giersch & Peter G. Peterson, 1980. "Trends in United States International Trade and Investment since World War II," NBER Chapters,in: The American Economy in Transition, pages 183-274 National Bureau of Economic Research, Inc.
  6. Paul A. Anderson, 1979. "Help for the regional economic forecaster: vector autoregression," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum.
  7. Thomas J. Sargent, 1979. "Estimating vector autoregressions using methods not based on explicit economic theories," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum.
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