Global and country-specific movements in real effective exchange rates: Implications for external competitiveness

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Abstract

Using the Bayesian factor model, we decompose real effective exchange rates, which are considered a measure of external competitiveness, into global and country-specific factors. Among several findings, we report a particular global trend in real exchange rates, but a substantial proportion of their variation is found to be country-specific. In line with this finding, we find that structural shifts, when they do exist, are contained in country-specific factors. Furthermore, consistent with economic theory, this global factor is closely related to a trend in the global interest rate, while country-specific factors are closely related to idiosyncratic movements in the countries’ own interest rates. Such a decomposition results in better understanding of the exchange rate-interest rate relationship, and therefore our results can be interpreted as evidence that external competitiveness is heterogeneous among countries and that economic policies can influence countries’ competitiveness.

Original languageEnglish
Pages (from-to)88-105
Number of pages18
JournalJournal of International Money and Finance
Volume76
DOIs
Publication statusPublished - 2017 Sep

Keywords

  • External competitiveness
  • Factor model
  • Real effective exchange rate
  • Variance decomposition

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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