The Common–Trend and Transitory Dynamics in Real Exchange Rate Fluctuations

This study explores the sources of real exchange rate fluctuations under the cur-rent float. Using a cointegration model of the real exchange rate, the innovations are decomposed into transitory and common–trend components. Both transitory and common–trend innovations are found to explain an appreciable portion of real exchange rate fluctuations, albeit their relative importance can vary across major currencies. Further analysis suggests that common–trend innovations are attribut-able to both productivity and monetary changes, albeit transitory innovations are linked primarily to monetary changes. The empirical results are largely consistent with an open–economy macroeconomic model