Testing for the fundamental determinants of the long run real exchange rate

Abstract

The methods of cointegration and error correction are used to test three models of the long run real exchange rate between the US and other G-10 countries. The models are as proposed by the theory of purchasing power parity, by the hypothesis of Fisher open rational expectations and by the analysis described in Allen and Stein (1989). (The dynamics of the real exchange rate, capital intensity and foreign debt, Brown University Working Paper). The results show that none of the models satisfactorily explain the dynamics of the real exchange rate. However, there is some evidence that the fundamental determinants of the real exchange rate include variables such as productivity, the terms of trad..