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Not so disconnected: exchange rates and the capital stock

Tarek Hassan (), Thomas M. Mertens () and Tony Zhang ()
Additional contact information
Thomas M. Mertens: Federal Reserve Bank of San Francisco, Postal: 101 Market Street Mail Stop 1130, San Francisco, CA 94105, USA, http://www.frbsf.org/economic-research/economists/thomas-mertens/
Tony Zhang: University of Chicago, Postal: 5807 S Woodlawn Avenue, Chicago, IL 60637, USA

No 2015-21, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: We investigate the link between stochastic properties of exchange rates and differences in capital-output ratios across industrialized countries. To this end, we endogenize capital accumulation within a standard model of exchange rate determination with nontraded goods. The model predicts that currencies of countries that are more systemic for the world economy (countries that face particularly volatile shocks or account for a large share of world GDP) appreciate when the price of traded goods in world markets is high. These currencies are better hedges against consumption risk faced by international investors because they appreciate in “bad” states of the world. As a consequence, more systemic countries face a lower cost of capital and accumulate more capital per worker. We estimate our model using data from seven industrialized countries with freely floating exchange rate regimes between 1984 and 2010 and show that cross-country variation in the stochastic properties of exchange rates accounts for 72% of the cross-country variation in capital-output ratios. In this sense, the stochastic properties of exchange rates map to fundamentals in the way predicted by the model.

JEL-codes: G00 (search for similar items in EconPapers)
Date: 2015-12-01
Note: Prepared for the International Seminar on Macroeconomics 2015.
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Related works:
Chapter: Not So Disconnected: Exchange Rates and the Capital Stock (2016)
Journal Article: Not so disconnected: Exchange rates and the capital stock (2016) Downloads
Working Paper: Not so Disconnected: Exchange Rates and the Capital Stock (2015) Downloads
Working Paper: Not so Disconnected: Exchange Rates and the Capital Stock (2015) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedfwp:2015-21

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DOI: 10.24148/wp2015-21

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