Sources of Real Exchange Rate Fluctuations: How Important are Nominal Shocks?

84 Pages Posted: 10 Jul 2000 Last revised: 30 Sep 2010

See all articles by Richard Clarida

Richard Clarida

Columbia University - Graduate School of Arts and Sciences - Department of Eco; National Bureau of Economic Research (NBER)

Jordi Galí

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Massachusetts Institute of Technology (MIT) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: February 1994

Abstract

This paper investigates empirically and attempts to identify the sources of real exchange rate fluctuations since the collapse of Bretton Woods. The paper's first two sections survey and extend earlier, non-structural empirical work on this subject by Campbell and Clarida (1987), Meese and Rogoff (1988), and Cumby and Huizinga (1990). The paper's main contribution is to build and estimate a three equation open macro model in the spirit of Dornbusch (1976) and Obstfeld (1985) and to identify the model's structural shocks - to demand, supply, and money -using the approach pioneered by Blanchard and Quah (1989). For two of the four countries we study, Germany and Japan, our structural estimates imply that monetary shocks, to money supply as well as to the demand for real money balances, explain a substantial amount of the variance of real exchange rates relative to the dollar. We find that demand shocks, to national saving and investment, explain the majority of the variance in real exchange rate fluctuations, while supply shocks explain very little. The model's estimated short run dynamics are strikingly consistent with the predictions of the simple textbook Mundell-Fleming model.

Suggested Citation

Clarida, Richard H. and Gali, Jordi, Sources of Real Exchange Rate Fluctuations: How Important are Nominal Shocks? (February 1994). NBER Working Paper No. w4658, Available at SSRN: https://ssrn.com/abstract=226963

Richard H. Clarida (Contact Author)

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Jordi Gali

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