A Cvar Scenario for a Standard Monetary Model Using Theory-Consistent Expectations

Abstract

A theory-consistent CVAR scenario describes a set of testable regularities capturing basic assumptions of the theoretical model. Using this concept, the paper considers a standard model for exchange rate determination and shows that all assumptions about the model's shock structure and steady-state behavior can be formulated as testable hypotheses on common stochastic trends and cointegration. While the scenario was rejected on essentially all counts, the results were informative about the cause of the empirical failure. It was the stationarity assumptions that were too restrictive to explain the long persistent swings in the real exchange rate and the interest rate differential.