http://worldcat.org/entity/work/id/204658819

Deviations of exchange rates from purchasing power parity : a story featuring two monetary unions

The proposition that exchange rates are volatile when allowed to float freely has become something of a stylized fact in the international finance literature (see, for example, Frenkel and Mussa (1980), MacDonald and Taylor (1992) and Frankel and Rose (1995)). Indeed, the volatility of exchange rates during the recent floating experience has led economists to advocate moving from an international monetary regime based on flexible exchange rates towards one based on greater exchange rate fixity (McKinnon (1988), Mundell (1992) and Williamson (1994)) and is also one of the central arguments made by proponents of greater monetary integration in Europe. The volatility of nominal exchange rates has also had implications for the behavior of real exchange rates. In particular, because prices in goods markets are generally regarded as being sticky (certainly in the short run), volatility in nominal exchange rates is transferred into comparable real exchange rates. This violation of PPP may be viewed as a second stylized fact in international finance. We examine the mean-reverting properties of real exchange rates, by comparing the unit root properties of a group of international real exchange rates with two groups of intra-national real exchange rates. Strikingly, we find that while the international real rates taken as a group appear mean-reverting, the intra-national rates are not. This is consistent with the view that while monetary shocks may be mean-reverting over the medium term, underlying real factors do generate long-term trends in real exchange rates.

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