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Does the Nominal Exchange Rate Regime Affect the Long Run Properties of Real Exchange Rates?

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  • Christian Dreger
  • Eric Girardin

Abstract

This paper examines whether the behaviour of the real exchange rate is associated with a particular regime for the nominal exchange rate, like fixed and flexible exchange rate arrangements. The analysis is based on 16 annual real exchange rates and covers a long time span, 1870-2006. Four subperiods are distinguished and linked to exchange rate regimes: the Gold Standard, the interwar float, the Bretton Woods system and the managed float thereafter. Panel integration techniques are applied to increase the power of the tests. Cross section correlation is embedded via common factor structures. The evidence shows that real exchange rates properties are affected by the exchange rate regime, although the impact is not very strong. A unit root is rejected in both fixed and flexible exchange rate systems. Regarding fixed-rate systems, mean reversion of real exchange rates is more visible for the Gold Standard. The half lives of shocks have increased after WWII, probably due to a higher stickiness of prices and a lower weight of international trade in the determination of exchange rates. Both for the periods before and after WWII, half lives are lower in flexible regimes. This suggests that the nominal exchange rate plays some role in the adjustment process towards PPP.

Suggested Citation

  • Christian Dreger & Eric Girardin, 2007. "Does the Nominal Exchange Rate Regime Affect the Long Run Properties of Real Exchange Rates?," Discussion Papers of DIW Berlin 746, DIW Berlin, German Institute for Economic Research.
  • Handle: RePEc:diw:diwwpp:dp746
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    References listed on IDEAS

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    Cited by:

    1. Hwa-Taek Lee & Gawon Yoon, 2013. "Does purchasing power parity hold sometimes? Regime switching in real exchange rates," Applied Economics, Taylor & Francis Journals, vol. 45(16), pages 2279-2294, June.

    More about this item

    Keywords

    Real exchange rate persistence; exchange rate regime; panel unit roots;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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