Long-Run Exchange Rate Modeling: A Survey of the Recent Evidence

IMF Working Papers, January 1, 1995

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Surveys the recent literature on long run, or equilibrium, exchange rate modeling.
Reviews the voluminous literature which tests for a unit root in real exchange rates and the closely related work on testing for a unit root in the residual from a regression of the nominal exchange rate on relative prices.
Argues that the balance of evidence is supportive of the existence of some form of long-run exchange rate relationship.
Notes that the form of this relationship does not accord exactly with a traditional representation of the long-run exchange rate and offers potential explanations for this lack of conformity.

Unit root testing in real exchange rates is central to the literature surveyed.
Testing for a unit root in the residual from a regression of the nominal exchange rate on relative prices is a closely related strand of work.
The balance of evidence supports the existence of some form of long-run exchange rate relationship.
The empirical form of the long-run relationship departs from the traditional representation of the long-run exchange rate, prompting potential explanations discussed in the paper.

Subjects: Consumer price indexes, Currencies, Exchange rate modelling, Exchange rates, Foreign exchange, Money, Prices, Purchasing power parity, Real exchange rates
Keywords: balance of payments, Consumer price indexes, Currencies, current account, Exchange rates, further evidence, mean reversion, pound sterling, price combination, Purchasing power parity, Real exchange rates, regression equation, time series, U.S. dollar, WP

IMF Working Paper: Long-Run Exchange Rate Modeling: A Survey of the Recent Evidence (Working Paper No. 1995/014, Ronald MacDonald).