Real Exchange Rate Dynamics Beyond Business Cycles

61 Pages Posted: 15 Apr 2020

See all articles by Dan Cao

Dan Cao

Georgetown University - Department of Economics

Martin D.D. Evans

Georgetown University - Department of Economics

Wenlan Luo

Tsinghua University - School of Economics & Management

Date Written: March 10, 2020

Abstract

We examine how medium-term movements in real exchange rates and GDP vary with international financial conditions. For this purpose, we study the international transmission of productivity shocks across a variety of IRBC models that incorporate different assumptions about the persistence of productivity shocks, the degree of international risk sharing and access to international asset markets. Using a new global solution method, we demonstrate that the transmission of productivity shocks depends critically on the proximity of a national economy to its international borrowing limit. We then show that this implication of the IRBC model is consistent with the behavior of the US-UK real exchange rate and GDP over the past 200 years. The model also produces a negative correlation between relative consumption growth and real depreciation rate consistent with more recent data, and hence offers a resolution of the Backus-Smith puzzle.

Keywords: Real Exchange Rates, International Real Business Cycles, Banking Crises, Backus-Smith Puzzle, Incomplete Markets, Global Solution Methods

JEL Classification: C60, F30, F31, F41, F44, G11

Suggested Citation

Cao, Dan and Evans, Martin D.D. and Luo, Wenlan, Real Exchange Rate Dynamics Beyond Business Cycles (March 10, 2020). Available at SSRN: https://ssrn.com/abstract=3552189 or http://dx.doi.org/10.2139/ssrn.3552189

Dan Cao

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States

Martin D.D. Evans (Contact Author)

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States
202-687-1570 (Phone)
202-687-6102 (Fax)

Wenlan Luo

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
China

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