Hostname: page-component-78c5997874-mlc7c Total loading time: 0 Render date: 2024-11-14T23:24:02.609Z Has data issue: false hasContentIssue false
  • English
  • Français

DETECTING SCAPEGOAT EFFECTS IN THE RELATIONSHIP BETWEEN EXCHANGE RATES AND MACROECONOMIC FUNDAMENTALS: A NEW APPROACH

Published online by Cambridge University Press:  23 November 2018

Lorenzo Pozzi  and
Barbara Sadaba
Lorenzo Pozzi
Affiliation:
Erasmus University Rotterdam & Tinbergen Institute
Barbara Sadaba*
Affiliation:
Bank of Canada
*
Address correspondence to: Barbara Sadaba, International Economic Analysis Department, 234 Wellington St., K1A 0G9 Ottawa ON, Canada. e-mail: [email protected]. Phone: (+1)6137827955. url: http://www.bankofcanada.ca/profile/barbara-sadaba/.
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper presents a new testing method for the scapegoat model of exchange rates. A number of steps are implemented to determine whether macro-fundamentals are scapegoats for the evolution of exchange rates. Estimation is conducted using a Bayesian Gibbs sampling approach applied to eight countries (five developed and three emerging) versus the USA over the period 2002Q1–2014Q4. The macro-fundamentals that we consider are real GDP growth, the inflation rate, the long-run nominal interest rate, and the current account to GDP ratio. We calculate the posterior probabilities that these macro-fundamentals are scapegoats. For the inflation rate, these probabilities are considerably higher than the imposed prior probabilities of ½ in five out of eight countries (in particular, the Anglo-Saxon economies).

Keywords

Exchange RateScapegoat ModelUnobserved ComponentState SpaceBayesian
Type
Articles
Information
Macroeconomic Dynamics , Volume 24 , Issue 4 , June 2020 , pp. 951 - 994
Copyright
© Cambridge University Press 2018

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

For constructive comments and suggestions on earlier versions of this paper, we thank two anonymous referees, Tino Berger, Gerdie Everaert, Francesco Ravazzolo, Job Swank, and Sunčica Vujić. The views expressed in this paper are those of the authors. No responsibility for them should be attributed to the Bank of Canada.

References

Bacchetta, P. and van Wincoop, E. (2004) A scapegoat model of exchange rate fluctuations. American Economic Review Papers and Proceedings 94, 114–118.CrossRefGoogle Scholar
Bacchetta, P. and van Wincoop, E. (2009) On the unstable relationship between exchange rates and macroeconomic fundamentals. NBER Working Paper Series, 15008.Google Scholar
Bacchetta, P. and van Wincoop, E. (2012) Modeling exchange rates with incomplete information. In: James, J., Marsh, I., and Sarno, L. (eds.), Handbook of Exchange Rates, pp. 375–390. Hoboken, NJ: Wiley.CrossRefGoogle Scholar
Bacchetta, P. and van Wincoop, E. (2013) On the unstable relationship between exchange rates and macroeconomic fundamentals. Journal of International Economics 91(1), 18–26.CrossRefGoogle Scholar
Bacchetta, P., van Wincoop, E. and Beutler, T. (2010) Can parameter instability explain the Meese-Rogoff puzzle? In: NBER International Seminar on Macroeconomics 2009, Volume 61, no. 1, pp. 125–173.Google Scholar
Bauwens, L., Lubrano, M. and Richard, J.-F. (2000) Bayesian inference in dynamic econometric models. Oxford: Oxford University Press.CrossRefGoogle Scholar
Byrne, J. and Nagayasu, J. (2012) Common factors of the exchange risk premium in emerging European markets. Bulletin of Economic Research 64(S1), 71–85.CrossRefGoogle Scholar
Carriero, A. (2006) Explaining US-UK interest rate differentials: A reassessment of the uncovered interest rate parity in a Bayesian framework. Oxford Bulletin of Economics and Statistics 68(S1), 879–899.CrossRefGoogle Scholar
Carter, C. and Kohn, R. (1994) On Gibbs sampling for state space models. Biometrika 81, 541–553.CrossRefGoogle Scholar
Cheung, Y. and Chinn, M. (2001) Currency traders and exchange rate dynamics: A survey of the US market. Journal of International Money and Finance 20, 439–471.CrossRefGoogle Scholar
Cheung, Y. and Erlandsson, U. G. (2005) Exchange rates and Markov Switching dynamics. Journal of Business and Economic Statistics 23(3), 314–320.CrossRefGoogle Scholar
Cheung, Y., Chinn, M. and Pascual, A. (2005) Empirical exchange rate models of the nineties: Are any fit to survive? Journal of International Money and Finance 24, 1150–1175.CrossRefGoogle Scholar
Engel, C. (1994) Can the Markov Switching model forecast exchange rates? Journal of International Economics 36(1–2), 151–165.CrossRefGoogle Scholar
Engel, C. and Hamilton, J. D. (1990) Long swings in the dollar: Are they in the data and do markets know it? American Economic Review 80(4), 689–713.Google Scholar
Engel, C. and West, K. (2005) Exchange rates and fundamentals. Journal of Political Economy 113(3), 485–517.CrossRefGoogle Scholar
Engel, C., Mark, N. and West, K. (2007) Exchange rate models are not as bad as you think. In: Acemoglu, D., Rogoff, K., and Woodford, M. (eds.), NBER Macroeconomics Annual 2007, pp. 381–441.Google Scholar
Fratzscher, M., Rime, D., Sarno, L. and Zinna, G. (2015) The scapegoat theory of exchange rates: The first tests. Journal of Monetary Economics 70, 1–21.CrossRefGoogle Scholar
Frühwirth-Schnatter, S. and Wagner, H. (2010) Stochastic model specification search for Gaussian and partial non-Gaussian state space models. Journal of Econometrics 154(1), 85–100.CrossRefGoogle Scholar
George, E. and McCulloch, R. (1993) Variable selection via Gibbs sampling. Journal of the American Statistical Association 88, 881–889.CrossRefGoogle Scholar
Geweke, J. (1992) Evaluating the accuracy of sampling-based approaches to the calculation of posterior moments. In: Berger, J., Bernardo, J., Dawid, A., and Smith, A. (eds.), Bayesian statistics. Oxford: Oxford University Press.Google Scholar
Groen, J., Paap, R. and Ravazzolo, F. (2013) Real-time inflation forecasting in a changing world. Journal of Business and Economic Statistics 31(1), 29–44.CrossRefGoogle Scholar
Hammond, G. (2011) State of the art of inflation targeting. In: Centre for Central Banking Studies Handbook, 4th ed., Volume 29. Bank of England.Google Scholar
Kim, C.-J. andNelson, C. R. (1999) State-Space Models with Regime Switching: Classical and Gibbs-Sampling Approaches with Applications. Cambridge, MA: MIT press.Google Scholar
Kim, S., Shephard, N. and Chib, S. (1998) Stochastic volatility: Likelihood inference and comparison with ARCH Models. Review of Economic Studies 65(3), 361–393.CrossRefGoogle Scholar
Meese, R. and Rogoff, K. (1983a) Empirical exchange rate models of the seventies: Do they fit out of sample? Journal of International Economics 14(1), 3–24.CrossRefGoogle Scholar
Meese, R. and Rogoff, K. (1983b) The out-of-sample failure of empirical exchange rate models: Sampling error or misspecification? In: Frenkel, J. (ed.), Exchange Rates and International Macroeconomics, pp. 67–105. Chicago: University of Chicago Press.Google Scholar
Meese, R. A. and Rogoff, K. (1988) Was it real? The exchange rate-interest differential over the modern floating-rate period. Journal of Finance 43, 933–948.CrossRefGoogle Scholar
Newey, W. and West, K. (1987) A simple positive semi-definite heteroskedasticity and autocorrelation consistent covariance matrix. Econometrica 55, 703–708.CrossRefGoogle Scholar
Obstfeld, M. and Rogoff, K. (2000) The six major puzzles in international macroeconomics: Is there a common cause? In: Bernanke, B., and Rogoff, K. (eds.), NBER Macroeconomics Annual 2000.Google Scholar
Rossi, B. (2006) Are exchange rates really random walks? Some evidence robust to parameter instability. Macroeconomic Dynamics 10(1), 20–38.CrossRefGoogle Scholar
Rossi, B. (2013) Exchange rate predictability. Journal of Economic Literature 51(4), 1063–1119.CrossRefGoogle Scholar
Sarno, L. and Schmeling, M. (2014) Which fundamentals drive exchange rates? A cross-sectional perspective. Journal of Money, Credit and Banking 46(2-3), 267–292.CrossRefGoogle Scholar
Sarno, L. and Sojli, E. (2009) The feeble link between exchange rates and fundamentals: Can we blame the discount factor? Journal of Money, Credit and Banking 41(2–3), 437–442.CrossRefGoogle Scholar
Sarno, L. and Valente, G. (2009) Exchange rates and fundamentals: Footloose or evolving relationship? Journal of the European Economic Association 7(4), 786–830.CrossRefGoogle Scholar