Sources of Fluctuations in Real and Nominal Exchange Rates

This paper attempts to distinguish empirically real versus nominal sources of fluctuations in real and nominal exchange rates. The distinction is obtained by imposing the following restriction on the bivariate vector autoregression of real and nominal exchange rates over the current flexible rate period: nominal shocks are required to have no permanent effect on the level of the real exchange rate. Given this identification scheme, the author analyzes the dynamic effects and relative importance of real and nominal shocks with regards to exchange rates. The findings indicate that real shocks dominate nominal shocks for both exchange rate series over short and long frequencies. Copyright 1992 by MIT Press.