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Real exchange rate has direct effects on trade particularly on international trade and has indirect effects on productions and employments, so it is crucial to understand the factors which determine its variations. This study analyses the main determinants of the real exchange rate and the dynamic adjustment of the real exchange rate following shocks to those determinants using yearly Ethiopian time series data covering the period 1971 to 2010. It begins with a review of literatures on Exchange rate, real exchange rate, determinants of the real exchange rate and provides an updated background on the exchange rate system in Ethiopia. An empirical model linking the real exchange rate to its theoretical determinants is then specified. This study had employed the cointegration and vector autoregression (VAR) analysis with impulse response and variance decomposition analyses to provide robust long run effects and short run dynamic effects on the real exchange rate. Share of investment, foreign exchange reserve, capital inflow and government consumption of non-tradable goods were the variable that have been found to have a long run relationship with the real exchange rate. The estimate of the speed of adjustment coefficient found in this study indicates that about a third of the variation in the real exchange rate from its equilibrium level is corrected within a year. The regression result of VECM reveals that terms of trade, nominal exchange rate, and one period lag of capital flow were the variables significantly affects the real exchange rate in the short run. However, the impulse response and variance decomposition analysis shows a better picture of the short run dynamics. The their analysis provided evidence that the Shocks to terms of trade, nominal exchange rate, capital inflow and share of investment have persistent effects on the real exchange rate in the short run. In general the regression results of both long run and short run models mostly suggest that the fluctuations of real exchange rates are ...

We follow the behavioral equilibrium exchange rate approach by Clark and MacDonald (1998) to derive equilibrium real effective exchange rates and currency misalignments for the US and its 16 major trading partners. We apply cointegration and panel cointegration techniques to derive fully countryspecific measures of misalignment and measures based on panel estimates. We formally test the forecast performance of pooled vs. heterogeneous estimators over a hold-back period and find that pooling the data delivers more accurate forecasts in the vast majority of cases although the implicit long-run homogeneity restriction is statistically rejected. This is especially remarkable, since we have given the heterogeneous estimator an 'unfair' advantage by choosing the country-specific model (of up to 21 possible ones) with the best out-of-sample performance prior to comparing it to two final panel specifications. Robustness of the results is supported by recently introduced cross-sectionally augmented panel unit root tests by Pesaran (2007) and bootstrapped error correction-based panel cointegration tests by Westerlund (2007), as well as different estimators. While we find strong evidence for the Balassa-Samuelson-effect, the evidence for other commonly hypothesized fundamentals is weak.

We study good-by-good deviations from the Law-of-One-Price (LOP) for over 1,800 retail goods and services between all European Union (EU) countries for the years 1975, 1980, 1985, and 1990. We find that for each of these years, after we control for differences in income and value-added tax (VAT) rates, there are roughly as many overpriced goods as there are underpriced goods between any two EU countries. We also find that good-by-good measures of cross-sectional price dispersion are negatively related to the tradeability of the good, and positively related to the share of non-traded inputs required to produce the good. We argue that these observations are consistent with a model in which retail goods are produced by combining a traded input with a non-traded input.

In this paper we examine the stability of the real exchange rate and the macroeconomic effects of alternative exchange rate regimes, including currency union, on real exchange rate behaviour. We focus on the Irish punt in order to exploit its diversity of experience over different nominal exchange rate regimes. We make both temporal and cross‐country comparisons of real exchange rate stability for the Irish punt with sterling, the US dollar and the German mark. We reach two conclusions on the basis of our results. The first is that for Ireland, as for most other countries, purchasing power parity provides a reasonably good description of actual exchange rate behaviour over the long run. Our second principal conclusion concerns regime effects. Currency union appears to matter. The real exchange rates we analyse are unambiguously less variable under currency union than under alternative exchange rate systems. Otherwise, however, we find no clear‐cut differences in behaviour across regimes.

One aim of this book is to examine the causes of fluctuations in the mark/dollar, pound/dollar, and yen/dollar real exchange rates for the period 1972-1994 with quarterly data to determine appropriate policy recommendations to reduce these movements. A second aim is to investigate whether the three real exchange rates are covariance-stationary or not and to which extent they are covariance-stationary, respectively. These aims are reached by using a two-country overshooting model for real exchange rates with real government expenditure and by applying Johansen's maximum likelihood cointegration procedure and a factor model of Gonzalo and Granger to this model

Uncovered interest parity has found little empirical support at short horizons.Subtracting expected inflation differentials from both sides of the uncovered interestparity relationship implies a similar relationship between real interest rate differentials and expected real exchange rate movements. Previous empirical work that has attemptedto test for this relationship has found little empirical support. Using measures of real interest rates derived from indexed bonds, we find that real exchange ratesmove in the direction predicted by real interest rate differentials, and that previousnegative results are probably attributable to errors in estimating inflation expectations.

A number of emerging markets have experienced substantial real exchange rate appreciationin recent years, generating concerns about competitiveness and prompting policymakers torespond with a combination of mitigating policies. This paper shows that fiscal policy can play a role in alleviating these pressures. Using a sample of 28 emerging market economies over 1983-2011, we estimate a dynamic model of the real exchange rate and find that a permanent fiscal adjustment may reduce appreciation pressures over the long term. Furthermore, the composition of public spending matters, with reductions