Revisiting the relationship between exchange rates and fundamentals

Shiu-Sheng Chen and Yu-Hsi Chou

Journal of Macroeconomics, 2015, vol. 46, issue C, 1-22

Abstract: In this paper, we apply the permanent–transitory decomposition method to analyze the role of permanent and transitory shocks in explaining the apparent weak link between nominal exchange rates and economic fundamentals. The results suggest that for most of the countries we investigate, including Finland, Italy, Portugal, France and Switzerland, transitory shocks dominate exchange rate fluctuations, while permanent shocks dominate the variations in economic fundamentals. The findings therefore provide an alternative interpretation of the “exchange rate disconnect puzzle”. Moreover, the results also suggest that comprehensive modeling of transitory components in empirical models should not be neglected in studies of the dynamics of exchange rates.

Keywords: Monetary fundamentals; Exchange rates; Permanent–transitory decomposition (search for similar items in EconPapers)
JEL-codes: C22 F31 F47 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jmacro:v:46:y:2015:i:c:p:1-22

DOI: 10.1016/j.jmacro.2015.07.004

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