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The commodity currency puzzle

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Abstract

This paper addresses the purchasing power parity (PPP) puzzle for a commodity currency. In particular, we analyse the real exchange rate behaviour in Norway, which has a primary commodity (oil) that constitutes the majority of its exports. A substantial part of the literature on commodity currencies has found that, despite controlling for the effect of commodity prices, PPP does not hold in the long run. We show that once we also control for the effect of the interest rate differential in the real exchange rate relationship, the discrepancies from PPP are fully accounted for. Furthermore, with the interest rate differential included in the long run real exchange rate relationship, the real oil price plays only a minor role. Adjustment to equilibrium (half-lives) is also substantially reduced, taking no more than one year on average. Hence, contrary to earlier findings on commodity currencies, we have effectively removed the PPP puzzle.

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File URL: http://www.sv.uio.no/econ/english/research/unpublished-works/working-papers/pdf-files/2005/Memo-32-2005.pdf
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Bibliographic Info

Paper provided by Oslo University, Department of Economics in its series Memorandum with number 32/2005.

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Length: 28 pages
Date of creation: 20 Dec 2005
Date of revision:
Publication status: Published in The Icfai Journal of Monetray Economics, 2008, pages 7-30.
Handle: RePEc:hhs:osloec:2005_032

Contact details of provider:
Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway
Phone: 22 85 51 27
Fax: 22 85 50 35
Email:
Web page: http://www.oekonomi.uio.no/indexe.html
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Keywords: Exchange rate; commodity currencies; real oil price; purchasing power parity; uncovered interest parity.;

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Cited by:
  1. Jean-Christian Lambelet & Alexander Mihailov, 2006. "The Triple-Parity Law," Computing in Economics and Finance 2006 33, Society for Computational Economics.
  2. Stephanos Papadamou & Thomas Markopoulos, 2012. "The Monetary Approach to the Exchange Rate Determination for a “Petrocurrency”: The Case of Norwegian Krone," International Advances in Economic Research, Springer, vol. 18(3), pages 299-314, August.

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