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Revisiting the Dollar-Euro Permanent Equilibrium Exchange Rate: Evidence from Multivariate Unobserved Components Models

Xiaoshan Chen and Ronald MacDonald

Working Papers from Business School - Economics, University of Glasgow

Abstract: We propose an alterative approach to obtaining a permanent equilibrium exchange rate (PEER), based on an unobserved components (UC) model. This approach offers a number of advantages over the conventional cointegration-based PEER. Firstly, we do not rely on the prerequisite that cointegration has to be found between the real exchange rate and macroeconomic fundamentals to obtain non-spurious long-run relationships and the PEER. Secondly, the impact that the permanent and transitory components of the macroeconomic fundamentals have on the real exchange rate can be modelled separately in the UC model. This is important for variables, where the long and short-run effects may drive the real exchange rate in opposite directions, such as the relative government expenditure ratio.

Keywords: Permanent Equilibrium Exchange Rate; Unobserved Components Model; Exchange rate forecasting. (search for similar items in EconPapers)
JEL-codes: F31 F47 (search for similar items in EconPapers)
Date: 2010-05
New Economics Papers: this item is included in nep-cba, nep-for and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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