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Real Exchange Rates and Fundamentals: A Cross-Country Perspective

Authors

  • LUCA ANTONIO RICCI,

  • GIAN MARIA MILESI-FERRETTI,

  • JAEWOO LEE


  • We are very grateful to Elisabetta Falcetti, Enrique Mendoza, Jonathan Ostry, Sam Ouliaris, Peter Pedroni, Alessandro Prati, IMF colleagues, participants in an IMF seminar, and especially Ken West and two anonymous referees for useful comments. Giang Do, Sarma Jayanthi, Jungjin Lee, and Fei Liu provided excellent research assistance. We are also indebted to Jean Salvati for writing a STATA routine that performs dynamic OLS. This paper should not be reported as representing the views of the IMF. The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or IMF policy.

Abstract

This paper employs newly constructed measures for productivity differentials, external imbalances, and commodity terms of trade to estimate a panel cointegrating relationship between real exchange rates and a set of fundamentals for a sample of 48 industrial countries and emerging markets. It finds evidence of a strong positive relation between the consumer price index-based real exchange rate and commodity terms of trade. The estimated impact of productivity growth differentials between traded and nontraded goods, while statistically significant, is small. Increases in net foreign assets, government consumption, and trade restrictions tend to be associated with appreciating real exchange rates.

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