Unit Roots and the Real Exchange Rate Before World War I: The Case of Britain and the U.S

Walter Enders

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: The popularity of the Monetary Approach to the Balance of Payments and the Exchange Rate brought renewed interest in Purchasing Power Parity (PPP). The essence of the Monetary Approach as advocated by Johnson (1976) and Frenkel (1978) was to combine a simple theory of the demand for money with the Purchasing Power Parity relationship in order to 'explain' movements in a nation's Official Settlements Balance or exchange rate. Lately, the Monetary Approach has come under attack because of large and persistent measured devia tions from PPP, Daniel (1986) and Dornbusch (1980) view these deviations as symptomatic of 'sticky' commodity prices; if commodity prices are sticky, changes in the nominal exchange rate will induce changes in the real exchange rate arid in deviations from PPP. Others attempt to explain the observed deviations within the context of a flexible-price framework; productivity changes, as in Stockman (1987), or delivery lags, as in Magee (1978), can give rise to optimal movements in a nation's real exchange rate. In spite of these different views, there is a wide support for the following synthesis of Mussa's (1979) 'stylized facts':

Date: 1987-06-01
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Journal Article: Unit roots and the real exchange rate before World War I: the case of Britain and the USA (1989)
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