Time-Varying Dynamics of the Real Exchange Rate: A Structural VAR Analysis

82 Pages Posted: 13 Mar 2010

See all articles by Haroon Mumtaz

Haroon Mumtaz

University of London - School of Sciences

Laura Sunder-Plassmann

affiliation not provided to SSRN

Date Written: March 10, 2010

Abstract

The aim of this paper is to explore the evolution of real exchange rate dynamics over time. We use a time-varying structural vector autoregression to investigate the role of demand, supply and nominal shocks and consider their impact on, and contribution to fluctuations in, the real exchange rate, output growth and inflation in four major economies over the past four decades. Our analysis therefore extends recent empirical research on evolving macroeconomic dynamics which has primarily focused on inflation and output and the time-varying impact of monetary policy on these variables. In addition we generalise recent VAR studies on exchange rate dynamics where the analysis is limited to a time-invariant setting. Our main results are as follows. The transmission of demand, supply and nominal shocks to the real exchange rate, output and inflation has changed substantially over time. Demand shocks have a larger impact on the real exchange rate after the mid-1980s for the United Kingdom, euro area and Japan and after the mid-1990s for Canada. Nominal shocks had a larger impact on output and inflation during the 1970s relative to the recent past. The forecast error variance of the real exchange rate is explained mainly by demand shocks with a smaller role for nominal shocks.

Keywords: Real exchange rate, time-varying VAR, sign restrictions, Bayesian estimation

JEL Classification: C32, E42, F31, F33

Suggested Citation

Mumtaz, Haroon and Sunder-Plassmann, Laura, Time-Varying Dynamics of the Real Exchange Rate: A Structural VAR Analysis (March 10, 2010). Bank of England Working Paper No. 382. Available at SSRN: https://ssrn.com/abstract=1568775 or http://dx.doi.org/10.2139/ssrn.1568775

Haroon Mumtaz (Contact Author)

University of London - School of Sciences ( email )

London, WC1E 7HX
United Kingdom

Laura Sunder-Plassmann

affiliation not provided to SSRN ( email )

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