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Research department working papers, a fundamental connection: exchange rates and macroeconomic expectations.
An emerging perception in international economics is that exchange rates are disconnected contemporaneously from macroeconomic fundamentals and are instead more closely tied to financial variables, particularly asset prices. The authors argue that this notion is incorrect. They use novel econometric methods to show that, while quarterly exchange rate changes are tightly linked to movements in currency risk premia, new information revealed by announcements about macroeconomic indicators can explain much of the variation in these risk premia. They also show that this same macroeconomic news also explains most of the variation in exchange rate changes at a quarterly frequency and that this news has even greater explanatory power during economic downturns and periods of financial uncertainty.
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What Drives the Exchange Rate?
We use a general open-economy wedge-accounting framework to characterize the set of shocks that can account for major exchange rate puzzles. Focusing on a near-autarky behavior of the economy, we show analytically that all standard macroeconomic shocks — including productivity, monetary, government spending, and markup shocks — are inconsistent with the broad properties of the macro exchange rate disconnect. News shocks about future macroeconomic fundamentals can generate plausible exchange rate properties. However, they show up prominently in contemporaneous asset prices, which violates the finance exchange rate disconnect. International shocks to trade costs, terms of trade and import demand, while potentially consistent with disconnect, do not robustly generate the empirical Backus-Smith, UIP and terms-of-trade properties. In contrast, the observed exchange rate behavior is consistent with risk-sharing (financial) shocks that arise from shifts in demand of foreign investors for home-currency assets, or vice versa.
Prepared for the IMF 24th Jacques Polak Annual Research Conference. We thank Harald Hau for an insightful discussion and Mark Aguiar, Andy Atkeson, Gita Gopinath, Pierre-Olivier Gourinchas, Maury Obstfeld, Kenneth Rogoff, Jón Steinsson, Adrien Verdelhan and seminar/conference participants for helpful comments, and Haonan Zhou for outstanding research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
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By integrating bibliometric methods with network visualization based on CiteSpace software, this study analyzed 4999 publications of exchange rate research from the Web of Science (WoS) Core Collection database during 1992 to 2021.
To do so, this study uses Rodrik’s (Citation 2008) paper, “The real exchange rate and economic growth,” as a benchmark to carry out a panel data analysis of the impact of currency undervaluation on economic growth. The data includes 93 countries over the period of 1990–2018.
Based on VAR analyses across 26 countries, we show that, although foreign exchange intervention (FXI) is effective in stabilizing the nominal exchange rate in the short run, its impacts on the real exchange rate are less significant: Limitations on nominal exchange rate flexibility may induce adjustments to the real exchange rate through domesti...
This highlights the importance of correctly assessing the exchange rate pass-through ratio (ERPTR)—defined in this paper as the percentage increase in consumer prices associated with a 1 percent depreciation of the effective exchange rate after one year.
This paper surveys the theoretical and empirical literature on the effects of the real exchange rate (RER) on international trade, economic development and growth.
This paper employs an updated algorithm and database for classifying exchange rate and anchor currency choice, to explore the evolution of the global exchange rate system, including parallel rates, capital controls and reserves.
This paper presents new stylized facts about exchange rates and their relationship with macroeconomic fundamentals. We show that macroeconomic surprises explain a large majority of the variation in nominal exchange rate changes at a quarterly frequency.
The exchange rate is one of the most important prices in open economies. Exchange rate volatility (ERV) has been studied in terms of its measurement, forecast and impact and relationship with other variables. This article proposes a bibliometric analysis of ERV compared with two databases Web of Science and Scopus.
This paper reviews the literature on exchange rate economics over the last two decades, with particular reference to recent developments. Exchange rate eco-nomics has been one of the most ac-tive-if challenging-areas of economic research over the last twenty years, and the amount of ground covered here is correspondingly vast. Thus, we can only
We use a general open-economy wedge-accounting framework to characterize the set of shocks that can account for major exchange rate puzzles. Focusing on a near-autarky behavior of the economy, we show analytically that all standard macroeconomic shocks — including productivity, monetary, government spending, and markup shocks — are ...