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Identifying Dornbusch's Exchange Rate Overshooting with Structural VECs: Evidence from Mexico

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  • Carlos Capistrán

    (Bank of America Merrill Lynch)

  • Daniel Chiquiar

    (Banco de México)

  • Juan R. Hernández

    (Banco de México)

Abstract

We propose an approach where, by imposing a rich longrun structure to a structural vector error-correction model (SVEC), we find a response of the exchange rate to monetary policy shocks consistent with Dornbusch's exchange rate overshooting hypothesis in data from Mexico. The model accommodates long-run theoretical relationships on macroeconomic variables (a purchasing power parity, an uncovered interest parity, a money demand, and a relationship between domestic and U.S. output). We identify, estimate, and test the long-run relationships using an ARDL methodology. We then impose a recursiveness assumption on the SVEC to identify the response of domestic variables to a monetary policy shock.

Suggested Citation

  • Carlos Capistrán & Daniel Chiquiar & Juan R. Hernández, 2019. "Identifying Dornbusch's Exchange Rate Overshooting with Structural VECs: Evidence from Mexico," International Journal of Central Banking, International Journal of Central Banking, vol. 15(5), pages 207-254, December.
    • Handle: RePEc:ijc:ijcjou:y:2019:q:5:a:6
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    2. I Made Suidarma & I Gede Sanica & Putu Cita Ayu & I Gusti Nengah Darma Diatmika, 2018. "Overshooting Indonesian Rupiah's Exchange Rate towards US Dollar: Dornbusch Model Hypotheses Test," International Journal of Economics and Financial Issues, Econjournals, vol. 8(5), pages 52-58.

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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications

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