Exchange Rate Disconnect In General Equilibrium
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Author | : Oleg Itskhoki |
Publisher | : |
Total Pages | : 90 |
Release | : 2017 |
Genre | : Econometric models |
ISBN | : |
Download Exchange Rate Disconnect in General Equilibrium Book in PDF, Epub and Kindle
We propose a dynamic general equilibrium model of exchange rate determination, which simultaneously accounts for all major puzzles associated with nominal and real exchange rates. This includes the Meese-Rogoff disconnect puzzle, the PPP puzzle, the terms-of-trade puzzle, the Backus- Smith puzzle, and the UIP puzzle. The model has two main building blocks - the driving force (or the exogenous shock process) and the transmission mechanism - both crucial for the quantitative success of the model. The transmission mechanism - which relies on strategic complementarities in price setting, weak substitutability between domestic and foreign goods, and home bias in consumption - is tightly disciplined by the micro-level empirical estimates in the recent international macroeconomics literature. The driving force is an exogenous small but persistent shock to international asset demand, which we prove is the only type of shock that can generate the exchange rate disconnect properties. We then show that a model with this financial shock alone is quantitatively consistent with the moments describing the dynamic comovement between exchange rates and macro variables. Nominal rigidities improve on the margin the quantitative performance of the model, but are not necessary for exchange rate disconnect, as the driving force does not rely on the monetary shocks. We extend the analysis to multiple shocks and an explicit model of the financial sector to address the additional Mussa puzzle and Engel's risk premium puzzle.
Author | : Oleg Itskhoki |
Publisher | : |
Total Pages | : 92 |
Release | : 2020 |
Genre | : |
ISBN | : |
Download Exchange Rate Disconnect in General Equilibrium Book in PDF, Epub and Kindle
We propose a dynamic general equilibrium model of exchange rate determination, which simultaneously accounts for all major puzzles associated with nominal and real exchange rates. This includes the Meese-Rogoff disconnect puzzle, the PPP puzzle, the terms-of-trade puzzle, the Backus- Smith puzzle, and the UIP puzzle. The model has two main building blocks -- the driving force (or the exogenous shock process) and the transmission mechanism -- both crucial for the quantitative success of the model. The transmission mechanism -- which relies on strategic complementarities in price setting, weak substitutability between domestic and foreign goods, and home bias in consumption -- is tightly disciplined by the micro-level empirical estimates in the recent international macroeconomics literature. The driving force is an exogenous small but persistent shock to international asset demand, which we prove is the only type of shock that can generate the exchange rate disconnect properties. We then show that a model with this financial shock alone is quantitatively consistent with the moments describing the dynamic comovement between exchange rates and macro variables. Nominal rigidities improve on the margin the quantitative performance of the model, but are not necessary for exchange rate disconnect, as the driving force does not rely on the monetary shocks. We extend the analysis to multiple shocks and an explicit model of the financial sector to address the additional Mussa puzzle and Engel's risk premium puzzle.
Author | : Yu-chin Chen |
Publisher | : |
Total Pages | : 54 |
Release | : 2021 |
Genre | : Foreign exchange rates |
ISBN | : |
Download Exchange Rate Disconnect and the General Equilibrium Puzzle Book in PDF, Epub and Kindle
This paper conducts general equilibrium (GE) estimation to evaluate the empirical contributions of macroeconomic shocks in explaining the exchange rate disconnect, excess volatility, and the uncovered interest parity (UIP) puzzles. We embed stochastic volatilities and limits-to-international arbitrage in a two-country New Keynesian model and estimate the GE system for the US and Euro area using higher-order approximation and full-information Bayesian methods. Assessing the roles of level vs. volatility shocks and linear vs. higher-order approximations, we find that shocks to macroeconomic fundamentals together with their uncertainties can account for a sizable portion-over 40%-of the observed exchange rate variations. Using the GE estimates, we then evaluate whether the fundamental shocks in our model can deliver the UIP relationship observed in the data, and more importantly, whether the results may differ conditionally vs. unconditionally. In line with findings in previous literature, several fundamental shocks individually can indeed generate patterns consistent with data. However, their contributions unconditionally in the GE setting are quantitatively insufficient to resolve the UIP puzzle. The presence of multiple shocks, their potential interactions, and the need for estimators to fit empirical dynamics of all observables beyond just the exchange rate are all likely reasons behind this "General Equilibrium Puzzle," which underscores the importance of GE estimation beyond simulations or partial-equilibrium analyses.
Author | : Michael B. Devereux |
Publisher | : |
Total Pages | : 48 |
Release | : 2000 |
Genre | : Foreign exchange rates |
ISBN | : |
Download A Simple Dynamic General Equilibrium Model of the Trade-off Between Fixed and Floating Exchange Rates Book in PDF, Epub and Kindle
Author | : Raman Uppal |
Publisher | : |
Total Pages | : 54 |
Release | : 1995 |
Genre | : |
ISBN | : |
Download Exchange Rate Volatility and Trade Book in PDF, Epub and Kindle
Author | : Camila Casas |
Publisher | : International Monetary Fund |
Total Pages | : 62 |
Release | : 2017-11-22 |
Genre | : Business & Economics |
ISBN | : 1484330609 |
Download Dominant Currency Paradigm: A New Model for Small Open Economies Book in PDF, Epub and Kindle
Most trade is invoiced in very few currencies. Despite this, the Mundell-Fleming benchmark and its variants focus on pricing in the producer’s currency or in local currency. We model instead a ‘dominant currency paradigm’ for small open economies characterized by three features: pricing in a dominant currency; pricing complementarities, and imported input use in production. Under this paradigm: (a) the terms-of-trade is stable; (b) dominant currency exchange rate pass-through into export and import prices is high regardless of destination or origin of goods; (c) exchange rate pass-through of non-dominant currencies is small; (d) expenditure switching occurs mostly via imports, driven by the dollar exchange rate while exports respond weakly, if at all; (e) strengthening of the dominant currency relative to non-dominant ones can negatively impact global trade; (f) optimal monetary policy targets deviations from the law of one price arising from dominant currency fluctuations, in addition to the inflation and output gap. Using data from Colombia we document strong support for the dominant currency paradigm.
Author | : Christoph Thoenissen |
Publisher | : |
Total Pages | : |
Release | : 1996 |
Genre | : |
ISBN | : |
Download Dynamic General Equilibrium Models of the Real Exchange Rate Book in PDF, Epub and Kindle
Author | : Torsten Persson |
Publisher | : |
Total Pages | : 46 |
Release | : 1980 |
Genre | : Fiscal policy |
ISBN | : |
Download Alternative Exchange Rate Regimes and the Transmission of Disturbances Book in PDF, Epub and Kindle
Author | : Piet Sercu |
Publisher | : |
Total Pages | : |
Release | : 1998 |
Genre | : |
ISBN | : |
Download Exchange Rate Volatility and International Trade Book in PDF, Epub and Kindle
Author | : Allan Bødskov Andersen |
Publisher | : |
Total Pages | : 25 |
Release | : 1998 |
Genre | : |
ISBN | : |
Download Exchange Rate Dynamics in an Intertemporal General Equilibrium Model with Normal Rigidities, Imperfect Competition, and Investments Book in PDF, Epub and Kindle