Private Consumption, Nontraded Goods and Real Exchange Rate: A Cointegration_Euler Equation Approach

Kenneth S. Lin

No 5731, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper presents an empirical study of real exchange rate movements from a consumer's perspective. Trade between two countries creates a link between real exchange rate and terms of trade. It is the private consumption of non-traded goods that induces an equilibrium relationship between real exchange rate and private consumption of traded and non-traded goods. We use Ogaki and Park's (1989) cointegration-Euler equation approach to explore long-run implications from the equilibrium relationship. Given the stationary preference shocks assumption, the testable restriction is that real exchange rate and private consumption of traded and non-traded goods in the home and foreign countries are cointegrated. The empirical evidence suggests that private consumption in the home and foreign countries accounts for a significant fraction of the long run movements of real exchange rate in South Korea and Taiwan. Accounting for real government consumption does not overturn the result.

Date: 1996-08
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Published as Changes in Exchange Rates in Rapidly Developing Countries. Ito,Takatoshiand Anne O. Krueger, eds., Chicago: The University of Chicago Press, 1999, pp.155-179.
Published as Private Consumption, Nontraded Goods, and Real Exchange Rate: Evidence from South Korea and Taiwan , Kenneth S. Lin. in Changes in Exchange Rates in Rapidly Developing Countries: Theory, Practice, and Policy Issues , Ito and Krueger. 1999

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