Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2000:4: Productivity shocks, monetary shocks, and the short- and long-run dynamics of exchange rates and relative prices

Michael Bergman (), Yin-Wong Cheung () and Kon S. Lai ()
Additional contact information
Michael Bergman: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden
Yin-Wong Cheung: Department of Economics, Postal: Department of Economics, University of California, Santa Cruz, CA 95064, USA
Kon S. Lai: Department of Economics, Postal: Department of Economics, California State University, Los Angeles, CA 90032, USA

Abstract: This study evaluates the individual roles of monetary and productivity shocks in real exchange rate fluctuations under the current float. Using a cointegration model of exchange rates and relative prices, the innovations are decomposed into transitory and common-trend parts. Both transitory and common-trend innovations are found to explain a significant portion of real exchange rate fluctuations, albeit their relative importance can vary across major currencies. Further analysis suggests that common-trend innovations are ascribed mostly to productivity shocks, whereas transitory innovations are governed by monetary shocks. The allowance for productivity shocks, however, appears insufficient to fully explain the high persistence of real exchange rates.

Keywords: Real exchange rate; real shock; monetary shock; transitory component; common trend

JEL-codes: F31; F41

32 pages, June 13, 2000

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