In Search of Dominant Drivers of the Real Exchange Rate

Authors

Wataru Miyamoto

Hyunseung Oh

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2022-09 | April 1, 2022

We uncover the major drivers of each macroeconomic variable and the real exchange rate at the business cycle frequency in G7 countries. In each country, the main drivers of key macro variables resemble each other and none of those account for a large fraction of the real exchange rate variances. We then estimate the dominant driver of the real exchange rate and find that (i) the shock is largely orthogonal to macro variables and (ii) the shock generates a significant deviation of the uncovered interest parity condition. We analyze international business cycle models that are consistent with our findings.

About the Authors
Thuy Lan Nguyen is a senior economist in the Economic Research Department of the Federal Reserve Bank of San Francisco. Learn more about Thuy Lan Nguyen