Dissecting Exchange Rates and Fundamentals in the Modern Floating Era: The Role of Permanent and Transitory Shocks

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In this paper, we apply a permanent–transitory decomposition method to analyze the link between nominal exchange rates and fundamentals in the modern floating era. The results suggest that transitory shocks dominate nominal exchange rate fluctuations, while permanent shocks dominate the variations in fundamentals. Therefore, the findings suggest that the nominal exchange rate should not be approximated by a pure random walk. Moreover, we find that unobserved fundamentals in the Taylor rule model can explain the transitory components in exchange rates.

Original languageEnglish
Pages (from-to)165-194
Number of pages30
JournalReview of International Economics
Issue number1
Publication statusPublished - 2017 Feb 1


ASJC Scopus subject areas

  • Geography, Planning and Development
  • Development

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