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Trend Fundamentals and Exchange Rate Dynamics

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  • Huber, Florian
  • Kaufmann, Daniel

Abstract

We estimate a multivariate unobserved components stochastic volatility model to explain the dynamics of a panel of six exchange rates against the US Dollar. The empirical model is based on the assumption that both countries' monetary policy strategies may be well described by Taylor rules with a time-varying inflation target, a time-varying natural rate of unemployment, and interest rate smoothing. The estimates closely track major movements along with important time series properties of real and nominal exchange rates across all currencies considered. The model generally outperforms a benchmark model that does not account for changes in trend inflation and trend unemployment. (authors' abstract)

Suggested Citation

  • Huber, Florian & Kaufmann, Daniel, 2016. "Trend Fundamentals and Exchange Rate Dynamics," Department of Economics Working Paper Series 214, WU Vienna University of Economics and Business.
    • Handle: RePEc:wiw:wus005:4808
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    Cited by:

    1. Phornchanok Cumperayot & Roy Kouwenberg, 2021. "The discount factor for expected fundamentals: Evidence from a panel of 25 exchange rates," International Economics, CEPII research center, issue 166, pages 167-176.

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    More about this item

    Keywords

    Exchange rate models; trend inflation; natural rate of unemployment; Taylor rule; unobserved components stochastic volatility model;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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