## Euro-Dollar Real Exchange Rate Dynamics in an Estimated Two-Country Model: What is Important and What is Not

_IMF Working Papers, July 1, 2006_

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## Bibliographic details
- Authors: Vicente Tuesta, Pau Rabanal
- Published: July 1, 2006
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451864373.001

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### Methodology
- Bayesian approach to estimate a standard two-country New Open Economy Macroeconomics model using data for the United States and the euro area.
- Performed model comparisons to study the importance of departing from:
  - the law of one price assumption, and
  - complete markets assumption.

### Key findings
- The baseline model:
  - does a good job in explaining real exchange rate volatility;
  - but overestimates volatility in output and consumption.
- Introducing incomplete markets:
  - allows the model to better match the volatilities of all real variables.
- Introducing sticky prices in Local Currency Pricing:
  - improves the fit of the baseline model;
  - does not improve the fit as much as introducing incomplete markets.
- Shocks driving real exchange rate behavior:
  - monetary shocks have played a minor role;
  - both demand and technology shocks have been important.

### Subjects and keywords emphasized in the study
- Subjects: Consumption, Exchange rates, Financial markets, Foreign exchange, Inflation, National accounts, Prices, Real exchange rates, Securities markets.
- Keywords: Bayesian estimation, closed economy, Consumption, demand shock, exchange rate, exchange rate-consumption anomaly, Exchange rates, Inflation, model comparison, Real exchange rates, Securities markets, standard deviation, technology shock, U.S. dollar, WP.

*Euro-Dollar Real Exchange Rate Dynamics in an Estimated Two-Country Model: What is Important and What is Not — Vicente Tuesta; Pau Rabanal (July 1, 2006).*

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/euro-dollar-real-exchange-rate-dynamics-in-an-estimated-two-country-model-what-is-important-19257_