Real Exchange Rate Dynamics Beyond Business Cycles

Cao, Dan and Evans, Martin and Lua, Wenlan (2020): Real Exchange Rate Dynamics Beyond Business Cycles.

Abstract

We examine how medium-term movements in real exchange rates and GDP vary with international financial conditions. For this purpose, we study the international transmission of productivity shocks across a variety of IRBC models that incorporate different assumptions about the persistence of productivity shocks, the degree of international risk sharing and access to international asset markets. Using a new global solution method, we demonstrate that the transmission of productivity shocks depends critically on the proximity of a national economy to its international borrowing limit. We then show that this implication of the IRBC model is consistent with the behavior of the US-UK real exchange rate and GDP over the past 200 years. The model also produces a negative correlation between relative consumption growth and real depreciation rate consistent with more recent data, and hence offers a resolution of the Backus-Smith puzzle.

• Item Type: MPRA Paper
• Language: English
• Keywords: Real Exchange Rates, International Real Business Cycles, Global Solution Methods
• Subjects: C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C60 - General; F - International Economics > F3 - International Finance > F30 - General; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F44 - International Business Cycles; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions

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