Equilibrium real exchange rates: closed-form theoretical solutions and some empirical evidence

Abstract

This paper generates closed-form theoretical solutions for the relationships among the real exchange rate, relative per capita consumption, and relative wealth in a stochastic dynamic general equilibrium model of two countries' representative consumers. The solutions offer insight into the robust cross-sectional relationship between relative per capita GDPs and relative national price levels established in Kravis and Lipsey (1983, 1987, 1988) in a manner consistent with equilibrium exchange rate theories and the productivity-differentials model of Balassa (1964) and Samuelson (1964). Application of panel data from Summers and Heston (1988) to the model's structural equations yields economically-plausible estimates of the elasticity of intertemporal substitution, the relative importance of nondashtradables in consumption, and the rate of time preference in several OECD countries relative to that in the United States.