Dynamic exchange rate behavior

Philip Roe Murray

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: The thesis sets forth the Dornbusch (1976) model of an open economy in order to interpret results obtained from the bivariate time series model invented by Blanchard and Quah (1989). A bivariate model of nominal and real exchange rates shows that so called real shocks contribute to the majority of exchange rate forecast error variances. In contrast, a bivariate model of the nominal exchange rate and output shows that so called nominal shocks contribute to the majority of nominal exchange rate forecast error variances. The contrast can be explained in the context of the Blanchard and Quah decomposition. An extension of Blanchard and Quah's bivariate model to the trivariate case also reconciles the differences. The study concludes that demand disturbances primarily account for nominal and real exchange rate movements. Income disturbances primarily account for output movements.

Date: 1992-01-01
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