Smooth Transitions and Mean Reversion in Real Effective Exchange Rates Patterns in Neighboring Areas

A recently developed unit root test is used to investigate the time series properties of the real effective exchange rate of ten OECD countries under conditions of structural change with the timing of the break determined endogenously. This technique tests the unit root null against stationarity around a smooth transition in linear trend. The results suggest that in most cases the real effective exchange rates are not mean reverting. This provides little support for the theory of purchasing power parity since the nominal exchange rate and relative prices will permanently tend to deviate from one another.