Real exchange rates in the long and short run: a panel co-integration approach

The main goal of this paper is to tackle the empirical issues of the real exchange rate literature by applying recently developed panel cointegration techniques to a structural long-run real exchange rate equation. Using annual data for 67 countries over 1966-97, we find evidence of cointegration between the real exchange rate and its fundamentals. I also find: (a) evidence of cointegration holds for all sub-samples of countries (classified by income or capital controls), (b) parameter constancy across units holds only for high income countries and low capital controls, (c) structural change in the cointegrating relationship around 1973, (d) estimated parameters consistent with theoretical values implied with calibrated parameters of preferences and technology, (e) deviations from the equilibrium are large and persistent with half-life (between 2.8 and 5) consistent with the consensus interval of 2.5-5 found in the literature (Murray and Papell, 2002)