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Exchange rates and prices: sources of sterling real exchange rate fluctuations 1973-94

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  • Mark S Astley
  • Anthony Garratt
Abstract
This paper attempts to identify the sources of UK exchange rate and relative consumer price fluctuations between 1973 and 1994. We follow Clarida and Gali (1994) in using the Blanchard and Quah (1989) structural VAR (SVAR) method to identify the effects of three structural shocks within a Dornbusch (1976)/Obstfeld (1995) model. We find that IS shocks underlay the majority of the variance of sterling real and nominal exchange rates. Aggregate supply (AS) shocks were the second most important source of such variations, while LM shocks played an extremely limited role. In contrast, the variance of UK relative consumer prices was primarily attributed to LM shocks. Combining those results with the estimated impulse response functions indicates that the sterling exchange rate depreciations over the floating rate period were largely associated with falls in UK relative consumer prices. But it would be inappropriate for policy-makers to base any future policy response to sterling fluctuations on that finding because: (a) the Lucas critique applies to it; and (b) it represents the average dynamic interaction over the sample period. We also find that: (i) the estimated impulse responses following each of the shocks are highly theory-consistent; and (ii) the periods in which the SVARs suggest that particular shocks were especially important can be linked to observed macroeconomic developments. both those findings indicate that the SVAR representations of the data have a high economic content.

Suggested Citation

  • Mark S Astley & Anthony Garratt, 1998. "Exchange rates and prices: sources of sterling real exchange rate fluctuations 1973-94," Bank of England working papers 85, Bank of England.
    • Handle: RePEc:boe:boeewp:85
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    3. A. H. Ahmad & Eric J. Pentecost, 2009. "Sources Of Real Exchange Rate Fluctuations: Empirical Evidence From Nine African Countries," Manchester School, University of Manchester, vol. 77(s1), pages 66-84, September.
    4. Imed Drine & Christophe Rault, 2009. "Une analyse économétrique des sources de fluctuations du taux de change réel dans trois pays en développement. Le cas du Maroc, des Philippines et de l'Uruguay," Revue économique, Presses de Sciences-Po, vol. 60(6), pages 1421-1453.
    5. Rafiq, Sohrab, 2013. "Sources of time-varying trade balance and real exchange rate dynamics in East Asia," Journal of the Japanese and International Economies, Elsevier, vol. 29(C), pages 117-141.
    6. McCoy, Daniel, 1997. "How useful is Structural VAR Analysis for Irish economics?," Research Technical Papers 2/RT/97, Central Bank of Ireland.
    7. Rebecca L Driver & Peter F Westaway, 2005. "Concepts of equilibrium exchange rates," Bank of England working papers 248, Bank of England.
    8. Alex Luiz Ferreira, 2004. "Are Real Interest Differentials Caused by Frictions in Goods or Assets Markets, Real or Nominal Shocks?," Studies in Economics 0407, School of Economics, University of Kent.
    9. Muhammad Arshad Khan & Saima Nawaz, 2018. "Does Pak-Rupee Exchange Rate Respond to Monetary Fundamentals? A Structural Analysis," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 57(2), pages 175-202.
    10. Dermot Hodson, 2003. "The Exchange Rate as an Adjustment Mechanism - A Structural VAR Approach to the Case of Ireland," The Economic and Social Review, Economic and Social Studies, vol. 34(2), pages 151-172.
    11. Andrew Mountford, 2005. "Leaning into the Wind: A Structural VAR Investigation of UK Monetary Policy," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 67(5), pages 597-621, October.
    12. Gottschalk, Jan & Döpke, Jörg & Kamps, Christophe, 2001. "Sources of Euro Real Exchange Rate Fluctuations: What Is Behind the Euro Weakness in 1999-2000?," Kiel Working Papers 1050, Kiel Institute for the World Economy (IfW Kiel).

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