Accounting for real and nominal exchange rate movements in New Zealand: a structural vector auto-regression approach

Abstract

This paper attempts to investigate the sources of fluctuations in New Zealand real and nominal exchange rates empirically. Using a three-equation structural vector auto-regression model, three types of shocks: the supply shock, the real demand shock and the nominal shock are identified by an extension of Blanchard and Quah's (1989) long-run identification technique. This study finds that in the short-run, real demand shocks are the main source of the real and nominal exchange rate fluctuations; while in the long-run, supply shocks dominate real demand shocks and nominal shocks in terms of the contribution to fluctuations in the real and nominal exchange rates. Overall, the empirical results I use the econometrical software package RATS for the empirical work in this thesis. indicate that nominal shocks have relatively minor influences on the bilateral real and nominal exchange rate movements between New Zealand and its major trading partners, Australia, the US and the UK, compared to real shocks (including both supply and real demand shocks).