Abstract
This paper employs a small open economy DSGE model, estimated over 19862009, to decompose the dynamic inuence of domestic and international prices on the Canada-US real exchange rate. While the real exchange rate mimics the dynamic behavior of the relative price of non-tradables in terms of tradables in response to a non-tradable sector-speci c disturbance, the purely tradable component dominates in the case of other shocks, irrespective of their structural origin. Variance decompositions reveal that the sources of the movements in the tradable component lie in unsystematic deviations from uncovered interest parity as well as import price mark-up shocks. Consequently, these disturbances are far more potent than internal tradable or non-tradable sector-speci c disturbances in driving real exchange rate uctuations. JEL classi cation: C11, F41 Keywords: New Open Economy Macroeconomics, Small Open Economy, NonTradables, Canada-US Real Exchange Rate, Bayesian Estimation. I acknowledge nancial support from the Inter-University Attraction Poles Program-Belgium Science Policy (Contract Number P6/07) and the Flemish Fund for Scienti c Research (FWO). I also thank Nicholas Groshenny, Robert Kollmann, Vivien Lewis, Gert Peersman, Ine Van Robays, Roland Straub, Raf Wouters and seminar participants at the Reserve Bank of New Zealand for helpful suggestions. All remaining errors are mine.
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