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The commodity currency puzzle

  • Bjørnland, Hilde C.

    (Dept. of Economics, University of Oslo)

  • Hungnes, Håvard

    ()

    (Statistics Norway, Research Department.)

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File URL: http://www.sv.uio.no/econ/english/research/unpublished-works/working-papers/pdf-files/2005/Memo-32-2005.pdf
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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
Web page: http://www.oekonomi.uio.no/indexe.html
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  2. Ken Froot & Kenneth Rogoff, . "Perspectives on PPP and Long-Run Real Exchange Rates," Working Paper 32027, Harvard University OpenScholar.
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  13. Q. Farooq Akram, 2004. "Oil prices and exchange rates: Norwegian evidence," Econometrics Journal, Royal Economic Society, vol. 7(2), pages 476-504, December.
  14. Frankel, Jeffrey A. & Rose, Andrew K., 1995. "A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries," Center for International and Development Economics Research (CIDER) Working Papers 233411, University of California-Berkeley, Department of Economics.
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  19. Johansen, Søren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 211-244.
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  23. Backus, David K. & Crucini, Mario J., 2000. "Oil prices and the terms of trade," Journal of International Economics, Elsevier, vol. 50(1), pages 185-213, February.
  24. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
  25. Bjørnland, Hilde C. & Hungnes, Håvard, 2003. "Fundamental determinants of the long run real exchange rate: The case of Norway," Memorandum 23/2002, Oslo University, Department of Economics.
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  36. Alexius, Annika, 1999. "Sources of Real Exchange Rate Fluctuations in the Nordic Countries," Working Paper Series 90, Sveriges Riksbank (Central Bank of Sweden).
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