Determinants of Uruguay's Real Effective Exchange Rate: A Mundell-Fleming Model Approach

TL;DR

This paper investigates the short-term determinants of Uruguay's real effective exchange rate using an extended Mundell-Fleming model, highlighting the roles of US lending rate, money supply, and inflation.

Contribution

It applies an extended Mundell-Fleming model with linear regression and Newey-West errors to identify key factors affecting Uruguay's REER, providing policy insights.

Findings

US lending rate increase leads to REER depreciation

Higher CPI and M2 are associated with REER depreciation

World interest rate has no significant impact

Abstract

This study examines the factors influencing the short-term real effective exchange rate (REER) in Uruguay by applying an extended Mundell-Fleming model. Analyzing the impact of the US lending rate (USLR), money supply (M2), inflation (CPI), and the world interest rate (WIR), the paper uses a linear regression model with Newey-West standard errors. Key findings reveal that an increase in the USLR, CPI, and M2 is associated with a depreciation of the REER. In contrast, WIR shows no significant impact. These findings are consistent with the theoretical expectations of the Mundell-Fleming model regarding open economies under floating exchange rates. Therefore, authorities should tighten monetary policy, control inflation, adjust fiscal strategies, and boost exports in response to Peso depreciation.