Revisiting the persistence of real exchange rates

Abstract

In this paper we provide new and robust evidence that panel regressions significantly reduce the estimated half-lives of real exchange rates in a sample of 21 countries. These results are obtained under dynamic panel models that control for non-purchasing power parity (PPP) equilibria. Small-sample bias does not have a significant impact on half-lives, since the increase in the half-life arising from the bias is more than compensated by the decrease of the half-life due to the control of non-PPP equilibria. Among the two sources of non-PPP equilibria, i.e., first, the Balassa-Samuelson effect and second, smooth shifts in mean, we find that, under a heterogeneous panel model, the first source results in a larger reduction of half-lives.