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Real Exchange Rate Levels, Productivity and Demand Shocks: Evidence from a Panel of 14 Countries

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  • Menzie Chinn
  • Louis Johnston

Abstract

This paper investigates the determinants of the real exchange rate using a panel of disaggregated data for the OECD countries. It also marries two literatures - one which uses panel data to measure relationships between changes in exchange rates to changes in the determinants, and the other which uses cointegration techniques to measure the long-run relationship between the level of the exchange rate and the level of the determining factors. The previous panel studies cannot account for deviations from long-run trend levels, while the extant literature using time series cointegration techniques can only intermittently detect and measure posited relationships. Estimating the relationships in levels is an interesting activity because it allows one to calculate trend real exchange rates. After surveying the previous litera- ture, a dynamic model of the real exchange rate is used to motivate the empi- rical exercise. In examining this problem, we exploit recent developments in the econometric analysis of nonstationary variables in panel data. The results indicate that under certain assumptions it is easier to detect cointegration in panel data than in the available time series; moreover, the estimates of reversion to trend are also estimated with greater precision. The most empirically successful models include productivity measures, government spend- ing ratios, and either the terms of trade, or the real price of oil. Using this latter model, we find that the implied equilibrium exchange rates indicate less overvaluation of the dollar than that implied by a naive version of purchasing power parity.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5709.

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Date of creation: Aug 1996
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Handle: RePEc:nbr:nberwo:5709

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  1. Jeffrey A. Frankel & Andrew K. Rose, 1995. "A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries," NBER Working Papers 5006, National Bureau of Economic Research, Inc.
  2. Holger C. Wolf & Alberto Giovannini & Jose De Gregorio, 1994. "International Evidence on Tradables and Nontradables Inflation," IMF Working Papers 94/33, International Monetary Fund.
  3. Asea, Patrick K & Corden, W Max, 1994. "The Balassa-Samuelson Model: An Overview," Review of International Economics, Wiley Blackwell, vol. 2(3), pages 191-200, October.
  4. Jose De Gregorio & Holger C. Wolf, 1994. "Terms of Trade, Productivity, and the Real Exchange Rate," Working Papers 94-19, New York University, Leonard N. Stern School of Business, Department of Economics.
  5. Matthew B. Canzoneri & Robert E. Cumby & Behzad Diba, 1996. "Relative Labor Productivity and the Real Exchange Rate in the Long Run: Evidence for a Panel of OECD Countries," NBER Working Papers 5676, National Bureau of Economic Research, Inc.
  6. Shang-Jin Wei & David C. Parsley, 1995. "Purchasing Power Disparity During the Floating Rate Period: Exchange Rate Volatility, Trade Barriers and Other Culprits," NBER Working Papers 5032, National Bureau of Economic Research, Inc.
  7. S. Micossi & Gian-Maria Milesi-Ferretti, 1994. "Real Exchange Rates and the Prices of Nontradable Goods," IMF Working Papers 94/19, International Monetary Fund.
  8. Osterwald-Lenum, Michael, 1992. "A Note with Quantiles of the Asymptotic Distribution of the Maximum Likelihood Cointegration Rank Test Statistics," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 461-72, August.
  9. Wolff, Christian C P, 1987. "Time-Varying Parameters and the Out-of-Sample Forecasting Performance of Structural Exchange Rate Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 5(1), pages 87-97, January.
  10. Cheung, Yin-Wong & Lai, Kon S., 1993. "Long-run purchasing power parity during the recent float," Journal of International Economics, Elsevier, vol. 34(1-2), pages 181-192, February.
  11. Marston, Richard C., 1990. "Systematic movements in real exchange rates in the G-5 : Evidence on the integration of internal and external markets," Journal of Banking & Finance, Elsevier, vol. 14(5), pages 1023-1044, November.
  12. Edison, Hali J, 1987. "Purchasing Power Parity in the Long Run: A Test of the Dollar/Pound Exchange Rate (1890-1978)," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(3), pages 376-87, August.
  13. Chinn, Menzie D. & Meese, Richard A., 1995. "Banking on currency forecasts: How predictable is change in money?," Journal of International Economics, Elsevier, vol. 38(1-2), pages 161-178, February.
  14. Levin, Andrew & Lin, Chien-Fu & James Chu, Chia-Shang, 2002. "Unit root tests in panel data: asymptotic and finite-sample properties," Journal of Econometrics, Elsevier, vol. 108(1), pages 1-24, May.
  15. Patrick K. Asea, 1994. "The Balassa-Samuelson Model: An Overview," UCLA Economics Working Papers 710, UCLA Department of Economics.
  16. Kenneth Rogoff, 1992. "Traded Goods Consumption Smoothing and the Random Walk Behavior of the Real Exchange Rate," NBER Working Papers 4119, National Bureau of Economic Research, Inc.
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