Revisiting the relationship between exchange rates and fundamentals

Shiu Sheng Chen, Yu Hsi Chou

Research output: Contribution to journalArticle

7 Citations (Scopus)

Abstract

In this paper, we apply the permanent-transitory decomposition method to analyze the role of permanent and transitory shocks in explaining the apparent weak link between nominal exchange rates and economic fundamentals. The results suggest that for most of the countries we investigate, including Finland, Italy, Portugal, France and Switzerland, transitory shocks dominate exchange rate fluctuations, while permanent shocks dominate the variations in economic fundamentals. The findings therefore provide an alternative interpretation of the "exchange rate disconnect puzzle". Moreover, the results also suggest that comprehensive modeling of transitory components in empirical models should not be neglected in studies of the dynamics of exchange rates.

Original languageEnglish
Pages (from-to)1-22
Number of pages22
JournalJournal of Macroeconomics
Volume46
DOIs
Publication statusPublished - 2015 Jan 1

Keywords

  • Exchange rates
  • Monetary fundamentals
  • Permanent-transitory decomposition

ASJC Scopus subject areas

  • Economics and Econometrics

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