Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/235291 
Year of Publication: 
2021
Series/Report no.: 
CESifo Working Paper No. 8921
Publisher: 
Center for Economic Studies and Ifo Institute (CESifo), Munich
Abstract: 
This paper estimates a model of the real exchange rate including standard fundamentals as well as two alternative measures of inflation expectations for five inflation targeting countries (UK, Canada, Australia, New Zealand, Sweden) over the period January 1993-July 2019. Both a benchmark linear ARDL model and a nonlinear ARDL (NARDL) specification are considered. The results suggest that the nonlinear framework is more appropriate to capture the behaviour of real exchange rates given the presence of asymmetries both in the long- and short-run. In particular, the speed of adjustment towards the PPP-implied long-run equilibrium is three times faster in a nonlinear framework, which provides much stronger evidence in support of PPP. Moreover, inflation expectations play an important role, with survey-based ones having a more sizable effect than market-based ones. Monetary authorities should aim to achieve a high degree of credibility to manage them and thus currency fluctuations effectively. The inflation targeting framework might be especially appropriate for this purpose.
Subjects: 
nonlinearities
asymmetric adjustment
PPP
real exchange rate
inflation expectations
JEL: 
C32
F31
G15
Document Type: 
Working Paper
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