Is the Exchange Rate a Shock Absorber or a Source of Shocks? New Empirical Evidence

This paper analyses the role of the real exchange rate in a structural vector autoregression framework for the United Kingdom, Euro area, Japan, and Canada vis-a´-vis the United States. A new identification strategy is proposed building on sign restrictions. The results are compared to the benchmark conventional approach of Clarida and Gali (1994) based on longrun zero restrictions. Although the restrictions are derived from the same theoretical model, the results are strikingly different. In contrast to the benchmark model, an important role for nominal shocks in explaining real exchange rate fluctuations is found. Hence, the exchange rate can rather be considered as a source of shocks instead of a shock absorber.

[1]  R. Dornbusch.  Expectations and Exchange Rate Dynamics , 1976, Journal of Political Economy.

[2]  P. Gregg,et al.  King Charles I , 1981 .

[3]  M. Obstfeld.  Floating Exchange Rates: Experience and Prospects , 1986 .

[4]  Charles I. Plosser,et al.  Stochastic Trends and Economic Fluctuations , 1987 .

[5]  Olivier J. Blanchard,et al.  The Dynamic Effects of Aggregate Demand and Supply Disturbances , 1988 .

[6]  M. Kawai.  Optimum Currency Areas , 1991 .

[7]  Barry Eichengreen,et al.  Macroeconomic Adjustment Under Bretton Woods and the Post-Bretton Woods Float: An Impulse-Response Analysis , 1992 .

[8]  J. Galí,et al.  Sources of Real Exchange Rate Fluctuations: How Important are Nominal Shocks? , 1994 .

[9]  Javier Vallés,et al.  Do exchange rates move to address international macroeconomic imbalances , 1996 .

[10]  Real Exchange Rate Fluctuations and the Business Cycle , 1996 .

[11]  Jon Faust,et al.  When Do Long-Run Identifying Restrictions Give Reliable Results? , 1997 .

[12]  Jon Faust.  The robustness of identified VAR conclusions about money , 1998 .

[13]  Jon Faust,et al.  The Robustness of Identified VAR Conclusions About Money , 1998 .

[14]  J. Rogers,et al.  Monetary Policy's Role in Exchange Rate Behavior , 1999 .

[15]  R. MacDonald.  What do We Really Know about Real Exchange Rates , 1999 .

[16]  F. Canova,et al.  Monetary Policy Misspecification in VAR Models , 2000 .

[17]  M. Funke.  Macroeconomic Shocks in Euroland vs the UK: Supply, Demand, or Nominal? , 2000 .

[18]  F. Canova,et al.  Monetary Disturbances Matter for Business Fluctuations in the G-7 , 2000 .

[19]  W. Buiter.  Optimal Currency Areas Scottish Economic Society/Royal Bank of Scotland Annual Lecture, 1999 , 2000 .

[20]  G. Peersman,et al.  The Monetary Transmission Mechanism in the Euro Area: More Evidence from VAR Analysis (Mtn Conference Paper) , 2001, SSRN Electronic Journal.

[21]  G. Peersman,et al.  The monetary transmission mechanism in the euro area: evidence from VAR analysis , 2003 .

[22]  F. Smets,et al.  Model Uncertainty and the Equilibrium Value of the Real Effective Euro Exchange Rate , 2002, SSRN Electronic Journal.

[23]  G. Peersman.  What Caused the Early Millennium Slowdown? Evidence Based on Vector Autoregressions , 2003 .

[24]  Gert Peersman,et al.  The Transmission of Monetary Policy in the Euro Area: Are the Effects Different Across Countries? , 2004 .