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Systematic Movements in Real Exchange Rates in the G-5: Evidence on theIntegration of Internal and External Markets

Richard C. Marston

NBER Working Paper No. 3332
Issued in April 1990
NBER Program(s):International Trade and Investment Program, International Finance and Macroeconomics Program

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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Document Object Identifier (DOI): 10.3386/w3332

Published: Journal of Banking and Finance, Vol. 14, November 1990, pp. 1023-1044

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