PPP Despite Real Shocks: An Empirical Analysis of the Norwegian Real Exchange Rate

Despite the emerging consensus on the validity of purchasing power parity (PPP) between trading countries in the long run, empirical evidence in favour of the PPP theory is scarce in data predominantly exposed to real shocks. This paper tests for PPP between Norway and its trading partners using quarterly observations from the post Bretton Woods period, in which the Norwegian economy has been exposed to numerous real shocks as repeated revaluation of oil and gas resources through new discoveries and price fluctuations. The paper undertakes an extensive examination of the behaviour of the Norwegian real and nominal exchange rates and shows that it is remarkably consistent with the PPP theory. Moreover, convergence towards the equilibrium level appears relatively fast, which is partly ascribed to the Norwegian government`s competitiveness preserving policies and the system of centralised wage bargaining.