Nonlinear Exchange Rate Adjustment in the Enlarged Eurozone: Evidence and Implications for Candidate Countries

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This paper sheds light on the importance of the validity of PPP hypothesis for the accessing process of the candidate countries towards EMU. The evidence of nonlinear adjustment in real exchange rates suggests the estimation of a nonlinear SETAR model. While linear half-life estimates are biased upward (five years on average), SETAR half-life estimates imply a faster reverting process (1.5 years on average). Moreover, we found that TPI-based real exchange rates are more appropriate than CPI-based real exchange rates in testing for PPP hypothesis. For the cluster of EMU countries and for the pre-EMU period, our nonlinear model confirms stationarity for the majority of the TPI-based real exchange rates with half-life estimates less than a year.