The paper addresses the question on what is the typical time horizon over which a full transmission of movements in the real exchange rate into real economy takes place. To this end, we base our analysis on the mixed-frequency small-scale dynamic factor model of Siliverstovs (2012) fitted to the Swiss data. In this paper, we augment the benchmark model with the real exchange rate of the Swiss franc vis-a-vis currencies of its 24 trading partners, while keeping the rest of model specification intact. We are interested in investigating the relationship between the common latent factor, representing the Swiss business cycle, and the real exchange rate. We explore the temporal relationship between these two variables by varying the time lag with which the real exchange rate enters the factor model by recording magnitude and statistical significance of the factor loading coefficient in the equation pertaining to the real exchange rate variable. Our main conclusion is that the fluctuations in the exchange rate start influencing real economy after one month and their effect is practically over after thirteen months. The largest effect is recorded at the time horizon of about six to nine months.
Factor model mixed-frequency data exchange rate GDP growth