A number of studies have analyzed how copper prices affect the Chilean economy

A number of studies have analyzed how copper prices

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A number of studies have analyzed how copper prices affect the Chilean economy through its effects on nominal exchange rates, terms of trade, and business cycles. The results suggest that a positive shock to the copper price leads to appreciation in nominal and real exchange rates, output expansion, and an increased inflation rate ( Cowan et al. 2007 ; Medina and Soto 2007 ). In the long run, copper prices appear to explain most of the fluctuations in the Chilean peso, but in the short run, other factors, including interest rate spread, global financial risk, and local pension funds foreign exchange derivative position, may explain these fluctuations ( Wu 2013 ). The fact that RER has acted as a shock absorber due to the flexible exchange rate regime, a rule-based fiscal policy, and a flexible inflation targeting system might explain why the Chilean economy has become increasingly resilient to copper price shocks in the last 25 years ( De Gregorio and Labbé 2011 ). This paper finds, based on the estimation of a CVAR model, that the long and persistent swings in the real exchange rate are compensated by movements in the interest rate spread, which restores the equilibrium in the product market when the real exchange rate moves away from its long-run benchmark value. Fluctuations in the copper price also explain the deviations of the real exchange 2 A CVAR scenario tests the empirical consistency of the basic underlying assumptions of a model rather than imposing them on the data from the outset ( Juselius 2017a ). 3 Duncan and Calderón ( 2003 ), and Froot and Rogoff ( 1995 ) present a thorough review of the literature on PPP testing.
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Econometrics 2017 , 5 , 29 3 of 21 rate from its long-run equilibrium value. The latter is consistent with the finding that in commodity exporters economies, variations in exchange rates are not random, but tightly linked to movements in commodity prices ( Kohlscheen et al. 2017 ). Additionally, the results indicate error-increasing behavior in prices and interest rates, which is consistent with the persistence in the data. The paper is organized as follows. Section 2 presents a theoretical framework based on IKE for exchange rate determination. Section 3 introduces the cointegrated vector of autoregressive model for variables that are integrated of order 2, I ( 2 ) . Section 4 presents stylized facts about Chilean data. Section 5 shows an empirical analysis of the data and presents a long-run structure. Section 6 concludes. 2. Theoretical Framework 2.1. Parity Conditions This subsection introduces one of the most important parity conditions of open-economy macroeconomic models: the purchasing power parity (PPP) condition. This parity condition states that once converted to a common currency, via nominal exchange rate, national price levels should equalize ( Bacchiocchi and Fanelli 2005 ). The absolute form (or strong form) of the PPP condition is expressed as: P d , t = S t P f , t (1) where P d , t is the domestic price level, P f , t is the foreign price level, S t is the nominal exchange rate
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