Sources of Fluctuations in the Real Exchange Rates and Trade Balances of the G-7: A Sign Restriction VAR Approach

Hyeon-seung Huh and Won Soon Kwon

Review of International Economics, 2015, vol. 23, issue 4, 715-737

Abstract: This paper estimates structural vector autoregression models of output, the real exchange rate and trade balance for the group of seven leading advanced economies (G-7). Unlike previous studies, we do not impose long-run purchasing power parity as an identifying assumption; instead, the shocks underlying the model are structurally identified using a set of theory-consistent sign restrictions. Empirical results show that nominal shocks account for most of the long-run variability in trade balances across the G-7 countries. We are able to attribute this finding to long-run movements in the real exchange rate, as the real exchange rate is significantly affected by nominal shocks in the long run.

Date: 2015
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