The relative price of tradables and nontradables and the U.S. trade balance

The real exchange rate is defined as the relative price of nontradables and tradables. An index of the relative price is constructed for the U.S. and used to explain net exports. The index appears to perform better in explaining net exports than a comparable purchasing power parity real exchange rate. The relative price of nontradables, in turn, is shown to be cointegrated with a set of variables that drive the demand for and supply of nontradables. These variables capture long-run structural and demographic changes of the U.S. economy, such as the increased demand for medical services. Copyright Kluwer Academic Publishers 1996