Real and nominal exchange rates in the long run: An empirical investigation

Abstract

This paper reports on econometric tests of the hypothesis that purchasing power parity holds as a long-run relationship using data on eight industrialized countries during the flexible exchange rate period. The empirical work proceeds by (i) testing whether nominal exchange rates and relative price levels are co-integrated and (ii) conducting impulse response analysis of long-run exchange rate and relative price level changes. To explain the data, Keynesian models suggest that shocks during the estimation period were due principally to exogenous shifts in aggregate demand, while equilibrium models suggest that monetary factors have been relatively more important.