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Real exchange rates and the relative prices of non-traded and traded goods: an empirical analysis

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  • Jan J J Groen
  • Clare Lombardelli

Abstract

This paper provides an empirical analysis of the decomposition of UK real exchange rates into the relative price of traded goods and the ratio of the relative price of non-traded to traded goods, and tests the prediction that deviations from the law of one price in tradable goods dominate real exchange rate variability only in the short run. UK bilateral real exchange rates are examined relative to a sample of six main OECD partners. The existence of a long-run relationship between real exchange rates and these corresponding relative price ratios is analysed using cointegrated vector autoregressive models. These show only limited evidence of a cointegrating relationship. The paper quantifies the severity of the deviations from the law of one price, and shows that these deviations are persistent relative to the length of the sample period. This motivates the use of a multi-country panel cointegration-testing framework, which produces evidence of a long-run relationship between the real exchange rate and the non-tradable component.

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Bibliographic Info

Paper provided by Bank of England in its series Bank of England working papers with number 223.

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Date of creation: Jun 2004
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Handle: RePEc:boe:boeewp:223

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Blog mentions

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  1. Is Inflation in Argentina Above 100%?
    by Nicolas Cachanosky in Punto de Vista Economico on 2013-04-25 03:10:38
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Cited by:
  1. Jan J J Groen & Akito Matsumoto, 2004. "Real exchange rate persistence and systematic monetary policy behaviour," Bank of England working papers 231, Bank of England.
  2. Marçal, Emerson Fernandes, 2013. "Exchange rate misalignments, interdependence, crises, and currency wars: an empirical assessment," Textos para discussão 348, Escola de Economia de São Paulo, Getulio Vargas Foundation (Brazil).

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