What Drives the Exchange Rate?

Oleg Itskhoki () and Dmitry Mukhin ()
Additional contact information
Oleg Itskhoki: UCLA Department of Economics
Dmitry Mukhin: UCLA Department of Economics

IMF Economic Review, 2025, vol. 73, issue 1, No 4, 86-117

Abstract: Abstract 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 macro economic 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 macro economic 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.

JEL-codes: F31 F41 F44 (search for similar items in EconPapers)
Date: 2025
References: Add references at CitEc
Citations:

Downloads: (external link)
http://link.springer.com/10.1057/s41308-024-00251-0 Abstract (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:pal:imfecr:v:73:y:2025:i:1:d:10.1057_s41308-024-00251-0

Ordering information: This journal article can be ordered from
http://www.springer. ... cs/journal/41308/PS2

DOI: 10.1057/s41308-024-00251-0

Access Statistics for this article

More articles in IMF Economic Review from Palgrave Macmillan, International Monetary Fund
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().