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The Political Economy of Real Exchange Rate Behavior: Theory and Empirical Evidence for Developed and Developing Countries, 1960-2010


  • Francisco A. Martínez-Hernández

    (Department of Economics, State University of New York)


Empirical results of the PPP hypothesis have constantly shown that relative prices do not converge to the same level, neither in the short nor the long run. Therefore the PPP explanation of the determination of the real exchange rate is not operative to get a reasonable measure of competitiveness at the international level. In this paper, we put forth a different approach based on the works of Ricardo, Marx, Harrod, and Shaikh, which argues that the real relative unit labor cost is the main force that explains the long-run behavior of the real exchange rate. In the second section of the paper we explain the theoretical underpinnings of our proposed approach. In the third section we analyze the role of the real interest rate differential in explaining real exchange rate misalignments. In the fourth section, we present a graphical analysis of the interrelation among the real effective exchange rate, the real unit labor cost ratio, the short-run real interest rate differential, and the trade balance for sixteen OECD countries, Taiwan, and three developing countries for the period 1960-2010. In the fifth section we investigate the long-run relationship between the latter three indexes through cointegrating and error correction models using the ARDLECM framework. The last section provides our conclusions.

Suggested Citation

  • Francisco A. Martínez-Hernández, 2017. "The Political Economy of Real Exchange Rate Behavior: Theory and Empirical Evidence for Developed and Developing Countries, 1960-2010," Working Papers 1716, New School for Social Research, Department of Economics.
  • Handle: RePEc:new:wpaper:1716

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    References listed on IDEAS

    1. John Sarich, 2006. "What do we know about the real exchange rate? A classical cost of production story," Review of Political Economy, Taylor & Francis Journals, vol. 18(4), pages 469-496.
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    More about this item


    Real adjusted unit labor cost; real effective exchange rate; real interest rate differential; trade balance; ARDL-ECM models.;

    JEL classification:

    • B12 - Schools of Economic Thought and Methodology - - History of Economic Thought through 1925 - - - Classical (includes Adam Smith)
    • B51 - Schools of Economic Thought and Methodology - - Current Heterodox Approaches - - - Socialist; Marxian; Sraffian
    • F50 - International Economics - - International Relations, National Security, and International Political Economy - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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