Exchange rate shocks and inflation comovement in the euro area

Danilo Leiva-Leon (), Eva Ortega and Jaime Martinez-Martin

No 1934, Working Papers from Banco de España

Abstract: This paper decomposes the time-varying effect of exogenous exchange rate shocks on euro area countries inflation into country-specific (idiosyncratic) and region-wide (common) components. To do so, we propose a flexible empirical framework that is based on dynamic factor models subject to drifting parameters and exogenous information. We show that exogenous shocks to the euro/USD account for over 50% of the nominal euro/USD exchange rate fluctuations in more than 1/3 of the quarters over the past six years – especially in turning points periods. Our main results indicate that headline inflation in euro area countries, and in particular its energy-related component, has significantly become more affected by these exogenous exchange rate shocks since the early 2010s, in particular, for the largest economies of the region. While such increasing sensitivity relies solely on a sustained surge in the degree of comovement for headline inflation, it is also based on a higher region-wide effect of the shocks for the case of energy inflation. Instead, purely exogenous exchange rate shocks do not seem to have a significant effect on the core component of headline inflation, which also displays a lower degree of comovement across euro area countries.

Keywords: exchange rate; inflation; factor model; structural VAR model (search for similar items in EconPapers)
JEL-codes: E31 F3 F41 (search for similar items in EconPapers)
Pages: 59 pages
Date: 2019-10
New Economics Papers: this item is included in nep-eec, nep-mac, nep-mon and nep-opm
References: Add references at CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
https://www.bde.es/f/webbde/SES/Secciones/Publicac ... /19/Fich/dt1934e.pdf First version, October 2019 (application/pdf)

Related works:
Journal Article: Exchange Rate Shocks and Inflation Co-movement in the Euro Area (2022)
Working Paper: Exchange rate shocks and inflation comovement in the euro area (2020)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bde:wpaper:1934

Access Statistics for this paper

More papers in Working Papers from Banco de España Contact information at EDIRC.
Bibliographic data for series maintained by Ángel Rodríguez. Electronic Dissemination of Information Unit. Research Department. Banco de España ().