Working Paper: NBER ID: w3067
Authors: Vittorio Grilli; Graciela Kaminsky
Abstract: Two propositions are common in the international finance literature: (1) the real exchange rate is a random walk, (2) the real exchange rate time series properties essentially depend on the nominal exchange rate regime. The first proposition has been used in support of the claim that PPP cannot even be considered a long run relationship since deviations from it are permanent in nature. The second proposition has been used as evidence of price stickiness. Contrary to the first proposition, this paper presents evidence that the random walk behavior of the real exchange rate is just a characteristic of the post-WWII period, while in the prewar period we observe the presence of transitory fluctuations. Also, although real exchange rate volatility appears to be different between fixed and flexible exchange rate regimes, these differences are not as systematic and large as the postwar data suggest.
Keywords: exchange rate regimes; real exchange rate; purchasing power parity
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nominal exchange rate regime (F33) | real exchange rate behavior (F31) |
| nominal exchange rate regime (F33) | persistence of shocks to the real exchange rate (F31) |
| post-war period (N44) | real exchange rate exhibits random walk behavior (F31) |
| pre-war period (N43) | real exchange rate shows transitory fluctuations (F31) |