Measuring the effects of dollar appreciation on Asia: A FAVAR approach |
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Institution: | 1. Federal Reserve Bank of San Francisco, 101 Market Street, San Francisco, CA 94595, USA;2. School of Economics, Shanghai University of Finance and Economics, 111 Wuchuan Rd, Shanghai 200433, China;3. Key Laboratory of Mathematical Economics (SUFE), Ministry of Education, Shanghai 200433, China;1. Department of Economics, Bentley University, 175 Forest Street, Waltham, MA, 02452, USA;2. Research Division, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO, 63106, USA;3. Department of Economics, Texas A&M University, 4228 TAMU, College Station, TX, 77843, USA;1. TU Dortmund University, Germany;2. University of Cologne, Germany;1. Bank for International Settlements, Centralbahnplatz 2, CH-4051 Basel, Switzerland;2. Vancouver School of Economics, 997–1873 East Mall, Vancouver, BC Canada V6T 1Z1 |
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Abstract: | Exchange rate shocks have mixed effects on economic activity in both theory and empirical VAR models. In this paper, we extend the empirical literature by considering the implications of a positive shock to the U.S. dollar in a factor-augmented vector autoregression (FAVAR) model for the U.S. and three large Asian economies: Korea, Japan and China. The FAVAR framework allows us to represent a country’s aggregate economic activity by a latent factor, generated from a broad set of underlying observable economic indicators. To control for global conditions, we also include in the FAVAR a “global conditions index,” which is another latent factor generated from the economic indicators of major trading partners. We find that a dollar appreciation shock reduces economic activity and inflation not only for the U.S. economy, but also for all three Asian economies. This result, which is robust to a number of alternative specifications, suggests that in spite of their disparate economic structures and policy regimes, the dollar appreciation shock affects the Asian economies primarily through its impact on U.S. aggregate demand; and this demand channel dominates the expenditure-switching channel that affects a country’s export competitiveness. |
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Keywords: | Monetary policy Real exchange rate FAVAR United States Korea Japan China Asia C3 E4 E5 F33 F37 F42 |
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