EXCHANGE-RATE MEAN REVERSION FROM REAL SHOCKS WITHIN AN INTERTEMPORALEQUILIBRIUM-MODEL

The post Bretton Woods era has been characterized by real exchange rat es that exhibit mean reversion, with mixed evidence as to whether this reversion is partial (PPP never holds) or essentially complete. This paper generates these stylized facts theoretically by synthesizing a s imple intertemporal open economy model with the elasticities approach to the current account. A central feature of the model is the existenc e of non-traded goods. The model can generate partial or approximately complete mean reversion for the real exchange rate (depending on para meter values) if innovations in output are made up of permanent and te mporary components. In addition, temporary output shocks generate a ty pe of hysteresis wherein the short-run path for the exchange rate perm anently alters its long-run equilibrium value. (JEL F31). Copyright (C ) 1996 Elsevier Science Ltd.