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Exchange Rates and Asymmetric Shocks in Small Open Economies

Annika Alexius () and Erik Post ()

No 2005:10, Working Paper Series from Uppsala University, Department of Economics

Abstract: If floating exchange rates stabilize shocks rather than create shocks, a country that joins a monetary union or fixes its exchange rate looses a stabilizing mechanism. We use a first difference structural VAR on trade weighted macroeconomic data to study the role of floating exchange rates for five "small open economies" with inflation targets. By including both domestic and foreign variables and using a combination of long and short-run restrictions, we identify asymmetric shocks more carefully than previous studies. Only in Sweden and Canada does the nominal exchange rate appreciate significantly in response to asymmetric demand shocks and depreciate to asymmetric supply shocks. Most exchange rate movements are caused by speculation and are not responses to fundamental shocks. However, these exchange rate shocks have negligible effects on output and inflation. Our findings indicate that exchange rates are neither stabilizing nor destabilizing but may be loosely characterized as disconnected from the rest of the economy.

Keywords: Exchange rates; asymmetric shocks; structural VAR (search for similar items in EconPapers)
JEL-codes: F31 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2005-03-15
New Economics Papers: this item is included in nep-ifn and nep-mon
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Journal Article: Exchange rates and asymmetric shocks in small open economies (2008) Downloads
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