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The Commodity Currency Puzzle

  • Hilde C Bjørnland
  • Håvard Hungnes

This paper addresses the Purchasing Power Parity (PPP) puzzle for a commodity currency. In particular, we analyze the real exchange rate behavior 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 deviations 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, this paper has effectively dealt with the PPP puzzle.

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Article provided by IUP Publications in its journal The IUP Journal of Monetary Economics.

Volume (Year): VI (2008)
Issue (Month): 2 (May)
Pages: 7-30

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Handle: RePEc:icf:icfjmo:v:06:y:2008:i:2:p:7-30
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