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Dissecting Exchange Rates and Fundamentals in the Modern Floating Era: The Role of Permanent and Transitory Shocks
Author(s) -
Chou YuHsi
Publication year - 2017
Publication title -
review of international economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.513
H-Index - 58
eISSN - 1467-9396
pISSN - 0965-7576
DOI - 10.1111/roie.12261
Subject(s) - economics , exchange rate , econometrics , random walk , monetary economics , keynesian economics , mathematics , statistics
In this paper, we apply a permanent–transitory decomposition method to analyze the link between nominal exchange rates and fundamentals in the modern floating era. The results suggest that transitory shocks dominate nominal exchange rate fluctuations, while permanent shocks dominate the variations in fundamentals. Therefore, the findings suggest that the nominal exchange rate should not be approximated by a pure random walk. Moreover, we find that unobserved fundamentals in the Taylor rule model can explain the transitory components in exchange rates.