Cointegration and exchange rate dynamics

Abstract

We utilize systems methods of estimation which impose the unit root structure to estimate both the long-run equilibrium relationship (the cointegrating vector) and the short-run dynamics of an open economy macroeconomic model in which the exchange rate and the domestic price level are endogenously determined for the United States. The model is estimated over the flexible exchange rate period and over two sub-periods chosen by structural change tests on the exchange rate. Both rational and theories consistent expectations are utilized. The models with theories consistent expectations outperform those with rational expectations.