Exchange-Rate Dark Matter

Martin Evans

No 2012/066, IMF Working Papers from International Monetary Fund

Abstract: Dark matter accounts for 83 percent of the matter in the universe and plays a central role in cosmology modeling. This paper argues that an analogous form of dark matter plays a similarly important role in international macroeconomics. Exchange-rate dark matter is invisible, but its existence can be inferred from observations on real exchange rates and interest rates. I first show that dark matter is the dominant driver of short- and medium-term changes in real exchange rates for the G-7 countries; accounting for more than 90 percent of the variance at the five-year horizon. I then develop a model in which risk shocks account for dark matter's role as a driver of exchange-rate dynamics and other macro variables.

Keywords: WP; real interest rate; risk premium; Exchange Rate Dynamics; Open-Economy Macro Models; Habits; Incomplete Markets; interest differential; risk shock; terms of trade; growth differential; marginal utility; exchange-rate dark matter; open economy; E.U. household; Real exchange rates; Consumption; Depreciation; Return on investment; Real interest rates; Europe (search for similar items in EconPapers)
Pages: 63
Date: 2012-03-01
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Citations: View citations in EconPapers (19)

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