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Real Exchange Rates and the Globalisation of Financial Markets

Author

Listed:
  • Adrian Blundell-Wignall

    (Reserve Bank of Australia)

  • Frank Browne

    (Organisation for Economic Co-operation and Development)

Abstract

A presumption in much of the earlier literature on real exchange rates suggests their behaviour is decoupled from fundamentals. This paper develops a theoretical model which allows for increased globalisation and integration of international financial markets in a world where goods markets are not perfectly integrated. Both cumulated current account balances and real interest differentials may be non-stationary within this framework. Appropriate portfolio diversification as net foreign asset positions diverge implies that the real exchange rates should be cointegrated with real interest differentials and net foreign asset (or liability) positions. Thus, for example, a cumulating overall current account surplus should lead to long-run appreciation of a country’s bilateral real exchange rate with any other country (given expected net returns) for portfolio diversification reasons. Real interest differentials, on the other hand, have an ambiguous impact on long-run real exchange rates. Empirical tests of this model show that three out of four major real exchange rates are cointegrated with these “fundamentals” variables. The underlying assumptions of the model – increasing financial integration and lack of goods market equilibrium – are supported by a series of supplementary tests.

Suggested Citation

  • Adrian Blundell-Wignall & Frank Browne, 1992. "Real Exchange Rates and the Globalisation of Financial Markets," RBA Research Discussion Papers rdp9203, Reserve Bank of Australia.
  • Handle: RePEc:rba:rbardp:rdp9203
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    File URL: http://www.rba.gov.au/publications/rdp/1992/pdf/rdp9203.pdf
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    References listed on IDEAS

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    20. repec:fth:harver:1463 is not listed on IDEAS
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