Long-run real exchange rates in the Four Little Dragons

Abstract

This paper analyses changes in the exchange rate arrangements and policy and their impact on the long-run real exchange rates of the Asian Four Little Dragons. It is found that purchasing power parity is a basic guide in formulating the exchange rate policy of the Four Little Dragons and that exchange rate regimes are very responsive to the effect of major external disturbances on prices. Thus, the exchange rate policy and arrangements are important factors in shaping the behaviour of the real exchange rates of the FLDs, which tend to return to the long-run average value. To test the null hypothesis that purchasing power parity does not hold between the Four Little Dragons and the United States, two cointegration tests, the augmented Dickey-Fuller (ADF) test and the Johansen test, are applied. As the symmetry and proportionality conditions are not supported by the data, the tests are conducted in a trivariate system. While the ADF test does not support PPP, evidence of cointegration is found by the Johans...