Real exchange rate dynamics: Relative importance of Taylor-rule fundamentals, monetary policy shocks, and risk-premium shocks

Chang Jin Kim, Cheolbeom Park

Research output: Contribution to journalArticlepeer-review

1 Citation (Scopus)

Abstract

We first show that the solution to the real exchange rate under the Taylor rule with interest rate smoothing can have two alternative representations—one based on a first-order difference equation and the other based on a second-order difference equation. Then, by comparing error terms from these two alternative representations and analyzing their second moments, we evaluate the relative importance of Taylor-rule fundamentals, monetary policy shocks, and risk-premium shocks in the dynamics of the real exchange rate. Empirical results suggest that the risk-premium shock is the largest contributor to real exchange rate movements for all the countries examined, with the Taylor-rule fundamentals and monetary policy shocks playing a limited role. These results are robust to various alternative sets of parameter values considered for the Taylor rule with interest rate smoothing.

Original languageEnglish
Pages (from-to)201-219
Number of pages19
JournalReview of International Economics
Volume27
Issue number1
DOIs
Publication statusPublished - 2019 Feb 1

ASJC Scopus subject areas

  • Geography, Planning and Development
  • Development

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