Persistence and volatility of real exchange rates: the role of supply shocks revisited

Release date
09/02/2016
Reference
DP2016/02
Authors
Britta Gehrke; Fang Yao
Published as

Gehrke, Britta and Fang Yao (2017). ‘Are supply shocks important for real exchange rates? A fresh view from the frequency-domain’, Journal of International Money and Finance, Elsevier, Volume 79(C), Pages 99-114, DOI: https://doi.org/10.1016/j.jimonfin.2017.09.008.

ISSN
1177-7567
This paper re-examines the role of supply shocks for real exchange rate fluctuations. First, in a structural VAR analysis, we combine long run and sign restrictions to identify productivity and non-productivity supply shocks. Second, we show that a variance decomposition in the frequency domain generates quantitatively different results compared to the standard forecast error variance decomposition. In particular, productivity shocks are the most important driver of US real effective exchange rate fluctuations at low frequencies, while real demand shocks are more salient at high frequencies. We use the spectrum at frequency zero to structurally decompose the persistence of the real exchange rate. Supply shocks explain more than half of the persistence of the exchange rate.