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Sources of exchange rate fluctuations with Taylor rule fundamentals

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  • Kempa, Bernd
  • Wilde, Wolfram

Abstract

This paper investigates the sources of exchange rate fluctuations when monetary policy follows a Taylor rule interest rate reaction function. We first present a simple dynamic exchange rate model with Taylor rule fundamentals which is triangular in the long-run impacts of shocks to the output market, the interest rate differential, and the Taylor rule. We then proceed to assess the relative importance of various shocks in exchange rate determination by estimating a structural VAR with long-run identification restrictions based on the triangular structure of the model. We find demand shocks to be less important than in earlier VAR studies, with both supply shocks and nominal shocks explaining a substantial part of real exchange rate fluctuations.

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  • Kempa, Bernd & Wilde, Wolfram, 2011. "Sources of exchange rate fluctuations with Taylor rule fundamentals," Economic Modelling, Elsevier, vol. 28(6), pages 2622-2627.
    • Handle: RePEc:eee:ecmode:v:28:y:2011:i:6:p:2622-2627
    DOI: 10.1016/j.econmod.2011.08.004
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    Cited by:

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    3. Yosra Baaziz, 2015. "Estimating Interest Rate Setting Behavior in Brazil: A LSTR Model Approach," Economies, MDPI, vol. 3(2), pages 1-17, April.
    4. Liu, Tie-Ying & Lin, Ye, 2024. "Who has mastered exchange rate ups and downs: China or the United States?," The North American Journal of Economics and Finance, Elsevier, vol. 70(C).
    5. Atif, Syed Muhammad & Sauytbekova, Moldir & Macdonald, James, 2012. "The determinants of australian exchange rate: a time series analysis," MPRA Paper 42309, University Library of Munich, Germany.
    6. Han, Liyan & Xu, Yang & Yin, Libo, 2018. "Does investor attention matter? The attention-return relationships in FX markets," Economic Modelling, Elsevier, vol. 68(C), pages 644-660.
    7. Baaziz, Yosra & Labidi, Moez & Lahiani, Amine, 2013. "Does the South African Reserve Bank follow a nonlinear interest rate reaction function?," Economic Modelling, Elsevier, vol. 35(C), pages 272-282.
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    9. Norman C. Miller, 2014. "Exchange Rate Economics," Books, Edward Elgar Publishing, number 14981.
    10. Chen, Chuanglian & Yao, Shujie & Ou, Jinghua, 2017. "Exchange rate dynamics in a Taylor rule framework," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 46(C), pages 158-173.

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    More about this item

    Keywords

    Exchange rate fluctuations; Taylor rule; Structural VAR;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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