What Drives the Exchange Rate? / Oleg Itskhoki, Dmitry Mukhin.

Format:

Book

Author/Creator:

Itskhoki, Oleg.

Contributor:

National Bureau of Economic Research.

Mukhin, Dmitry.

Series:

Working Paper Series (National Bureau of Economic Research) no. w32008.

NBER working paper series no. w32008

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2023.

Summary:

We use a general open-economy wedge-accounting framework to characterize the set of shocks that can account for major exchange rate puzzles. Focusing on a near-autarky behavior of the economy, we show analytically that all standard macroeconomic shocks -- including productivity, monetary, government spending, and markup shocks -- are inconsistent with the broad properties of the macro exchange rate disconnect. News shocks about future macroeconomic fundamentals can generate plausible exchange rate properties. However, they show up prominently in contemporaneous asset prices, which violates the finance exchange rate disconnect. International shocks to trade costs, terms of trade and import demand, while potentially consistent with disconnect, do not robustly generate the empirical Backus-Smith, UIP and terms-of-trade properties. In contrast, the observed exchange rate behavior is consistent with risk-sharing (financial) shocks that arise from shifts in demand of foreign investors for home-currency assets, or vice versa.

Notes:

Print version record

December 2023.