Sources of Real Exchange Rate Fluctuations in the Nordic Countries

In an attempt to move beyond the purchasing power parity hypothesis, this paper studies two issues. First, the causes of movements of real exchange rates are investigated. In contrast to the typical result, supply shocks are found to dominate the long-run variance decompositions for all countries. This suggests that productivity developments are the most important determinant of long-run movements in real exchange rate. A second topic is the relative importance of stationary and non-stationary components of real exchange rates. Also in contrast to previous findings, transitory shocks are more important than permanent shocks for three of the four countries.