Nonlinearities and Asymmetric Adjustment to PPP in an Exchange Rate Model with Inflation Expectations

26 Pages Posted: 8 Mar 2021

See all articles by Christina Anderl

Christina Anderl

London South Bank University

Guglielmo Maria Caporale

Brunel University London - Department of Economics and Finance; London South Bank University; CESifo (Center for Economic Studies and Ifo Institute); German Institute for Economic Research (DIW Berlin)

Date Written: 2021

Abstract

This paper estimates a model of the real exchange rate including standard fundamentals as well as two alternative measures of inflation expectations for five inflation targeting countries (UK, Canada, Australia, New Zealand, Sweden) over the period January 1993-July 2019. Both a benchmark linear ARDL model and a nonlinear ARDL (NARDL) specification are considered. The results suggest that the nonlinear framework is more appropriate to capture the behaviour of real exchange rates given the presence of asymmetries both in the long- and short-run. In particular, the speed of adjustment towards the PPP-implied long-run equilibrium is three times faster in a nonlinear framework, which provides much stronger evidence in support of PPP. Moreover, inflation expectations play an important role, with survey-based ones having a more sizable effect than market-based ones. Monetary authorities should aim to achieve a high degree of credibility to manage them and thus currency fluctuations effectively. The inflation targeting framework might be especially appropriate for this purpose.

JEL Classification: C320, F310, G150

Suggested Citation

Anderl, Christina and Caporale, Guglielmo Maria, Nonlinearities and Asymmetric Adjustment to PPP in an Exchange Rate Model with Inflation Expectations (2021). CESifo Working Paper No. 8921, Available at SSRN: https://ssrn.com/abstract=3798942

Christina Anderl

London South Bank University ( email )

103 Borough Road
London, Greater London SE1 OAA
United Kingdom

Guglielmo Maria Caporale (Contact Author)

Brunel University London - Department of Economics and Finance ( email )

Kingston Lane
Marie Jahoda Building
Uxbridge, Middlesex UB8 3PH
United Kingdom
+44 1895 266713 (Phone)
+44 1895 269770 (Fax)

HOME PAGE: http://www.brunel.ac.uk/about/acad/bbs/bbsstaff/ef_staff/guglielmocaporale/

London South Bank University ( email )

Centre for Monetary and Financial Economics
London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstra├če 58
Berlin, 10117
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
14
Abstract Views
77
PlumX Metrics