Multilateral adjustment,regime switching and real exchange rate dynamics |
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| Affiliation: | 1. Bank of Canada, 234 Laurier Avenue West, Ottawa, ON, Canada K1A 0G9;2. Bank of Canada, Canada;3. Graduate School of Economics, Hitotsubashi University, 2-1 Naka, Kunitachi, Tokyo 186-8601, Japan;1. Accounting and Finance, Faculty of Business and Public Administration, University of Zaragoza, Plaza de la Constitución s/n, Huesca 22003, Spain;2. Quantitative Methods Department, Economics Faculty, University of Zaragoza, C Gran Vía no. 2, Zaragoza 50018, Spain;3. Accounting and Finance, Economics Faculty, University of Zaragoza, C Gran Vía no. 2, Zaragoza 50018, Spain;1. Department of Mathematics and Research Institute of Natural Science, Gyeongsang National University, Jinju 660-701, Republic of Korea;2. Department of Mathematics and Statistics, York University, 4700 Keele St., Toronto, ON, Canada;1. Department of International Business, Feng Chia University, 100 Wenhwa Rd., Seatwen, Taichung 40724, Taiwan, ROC;2. Gordon Ford College of Business, Western Kentucky University, Bowling Green, KY 42101, USA;1. Department of Economics, Faculty of Business and Economics, Eastern Mediterranean University, Cyprus;2. Department of Economics, Stellenbosch University, South Africa;3. Department of Economics, University of Pretoria, Pretoria 0002, South Africa |
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| Abstract: | The purpose of this paper is to examine the role of multilateral adjustment to U.S. external imbalances in driving bilateral real exchange rate movements by developing a new regime-switching model that consists of a Markov-switching model with a time-varying transition matrix that depends on a threshold variable. Consequently, the dynamics of the real exchange rate can be modeled in the context of two regimes: one in which multilateral adjustment to large U.S. external imbalances is an important factor driving movements in the real exchange rate and the second in which the real exchange rate is driven mainly by country-specific macroeconomic fundamentals. We apply this model to the bilateral real Canada–U.S. dollar exchange rate and compare its performance to several other alternative models. All of the models are estimated using a Bayesian approach. Our findings suggest that during periods of large U.S. imbalances, an exchange rate model for the real Canada–U.S. dollar exchange rate should allow for multilateral adjustment effects. |
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| Keywords: | Exchange rates Markov-switching model Bayesian methods |
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