Systematic Movements in Real Exchange Rates in the G-5: Evidence on theIntegration of Internal and External Markets
Richard C. Marston
Many recent studies have documented the random behavior of
real exchange rates. This paper shows that real exchange rates
defined for different sectors of an economy move closely together
with one another even though each of the sectoral real exchange
rates taken alone has a large random component. The sectoral
real exchange rates are tied together by internal price links due
to factor mobility within each national economy. Any differences
between real exchange rates which develop, moreover, can be
explained almost entirely by productivity differentials, at least
in the long run. This paper contrasts the strong ties which bind
together prices from different sectors internally with ties that
bind the prices of goods from the same sector internationally.
Prices are shown to be much more highly correlated internally
than externally because flexible exchange rates disrupt normal
pricing relationships between goods from different countries.
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