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A1395
Topic: Contributed on Macroeconometrics Title: Trend fundamentals and exchange rate dynamics Authors:  Florian Huber - Vienna University of Economics and Business (Austria) [presenting]
Daniel Kaufmann - University of Neuchatel (Switzerland)
Abstract: We estimate a multivariate unobserved-components stochastic-volatility model to explain the behavior of a panel of six exchange rates against the US Dollar. The empirical model is based on the assumption that both countries monetary policy strategy may be well described by a Taylor rule with a time-varying inflation target and interest rate smoothing. This implies that the real exchange rate is determined by expectations about the relative trend inflation rates, the inflation gaps, the unemployment gaps and the short-term interest rates. The estimates closely track major movements along with important time series properties of the real and nominal exchange rate across all countries considered. The model generally outperforms a simple benchmark model that does not account for changes in trend inflation and trend unemployment.