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254 CHAPTER 8. THE MUNDELL-FLEMING MODEL(8.49)—(8.57) form a system of 9 equations in 9 unknowns and implicitlydeÞne F 0 . Once the F j are obtained, you can do impulse response analysesand forecast error variance decompositions using the ‘structural’response matrices F j .Table 8.1: Structural VAR forecast error variance decompositions forreal exchange rate depreciation1month36 monthsSupply Demand Money Supply Demand MoneyBritain 0.378 0.240 0.382 0.331 0.211 0.458Germany 0.016 0.234 0.750 0.066 0.099 0.835Japan 0.872 0.011 0.117 0.810 0.071 0.119Clarida and Gali estimate a structural VAR using quarterly datafrom 1973.3 to 1992.4 for the US, Germany, Japan, and Canada Theirimpulse response analysis revealed that following a one-standard deviationnominal shock, the real exchange rate displayed a hump shape,initially depreciating then subsequently appreciating. Real exchangerate dynamics were found to display delayed overshooting.We’ll re-estimate the structural VAR using 4 lags and monthly datafor the US, UK, Germany, and Japan from 1976.1 through 1997.4. Thestructural impulse response dynamics of the levels of the variables aredisplayed in Figure 8.9. As predicted by the theory, supply shockslead to a permanent real deprecation and demand shocks lead to apermanent real appreciation. The US-UK real exchange rate does notexhibit delayed overshooting in response to monetary shocks. The realdollar-pound rate initially appreciates then subsequently depreciatesfollowing a positive monetary shock. The real dollar-deutschemark ratedisplays overshooting by Þrst depreciating and then subsequently appreciating.The real dollar-yen displays Dornbusch-style overshooting.Money shocks are found to contribute a large fraction of the forecasterror variance both the long run as well as at the short run for thereal exchange rate. The decompositions at the 1-month and 36-monthforecast horizons are reported in Table 8.1