Working Paper Series, Department of Economics, Uppsala University
No 2005:10:
Exchange Rates and Asymmetric Shocks in Small Open Economies
Annika Alexius and Erik Post ()
Abstract: If floating exchange rates stabilize shocks rather than
create shocks, a country that joins a monetary union or fixes its exchange
rate looses a stabilizing mechanism. We use a first difference structural
VAR on trade weighted macroeconomic data to study the role of floating
exchange rates for five "small open economies" with inflation targets. By
including both domestic and foreign variables and using a combination of
long and short-run restrictions, we identify asymmetric shocks more
carefully than previous studies. Only in Sweden and Canada does the nominal
exchange rate appreciate significantly in response to asymmetric demand
shocks and depreciate to asymmetric supply shocks. Most exchange rate
movements are caused by speculation and are not responses to fundamental
shocks. However, these exchange rate shocks have negligible effects on
output and inflation. Our findings indicate that exchange rates are neither
stabilizing nor destabilizing but may be loosely characterized as
disconnected from the rest of the economy.
Keywords: Exchange rates; asymmetric shocks; structural VAR; (follow links to similar papers)
JEL-Codes: F31; (follow links to similar papers)
31 pages, March 15, 2005
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