Taylor rules and the Canadian–US equilibrium exchange rate

Tino Berger and Bernd Kempa

Journal of International Money and Finance, 2012, vol. 31, issue 5, 1060-1075

Abstract: This paper identifies the Canadian–US equilibrium exchange rate based on a simple structural model of the real exchange rate, in which monetary policy follows a Taylor-rule interest rate reaction function. The exchange rate is explained by relative output and inflation as observable variables, and by unobserved equilibrium rates as well as unobserved transitory components in output and the exchange rate. Using Canadian data over 1974–2009 we jointly estimate the unobserved components and the structural parameters using the Kalman filter and Bayesian technique. We find that Canada's equilibrium exchange rate evolves smoothly and follows a trend depreciation. The transitory component is found to be very persistent but much more volatile than the equilibrium rate, resulting in few but prolonged periods of currency misalignments.

Keywords: Equilibrium exchange rate; Unobserved components; Kalman filter; Bayesian analysis; Importance sampling (search for similar items in EconPapers)
JEL-codes: C11 C32 F31 F41 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (1)

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Working Paper: Taylor rules and the Canadian-US equilibrium exchange rate (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:31:y:2012:i:5:p:1060-1075

DOI: 10.1016/j.jimonfin.2011.12.010

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