NONSTATIONARITY OF REAL EXCHANGE-RATES IN THE G7 COUNTRIES - ARE THEYCOINTEGRATED WITH REAL VARIABLES

Using monthly data for the G7 countries in the post-Bretton Woods floa ting rate period, this paper demonstrates that almost all bilateral re al exchange rates have unit roots and, hence, are nonstationary. Conse quently, it rejects simple PPP as a long-run relationship. The paper a lso shows that many of these real exchange rates are cointegrated with other real economic variables such as relative labor productivity, te rms-of-trade ratios, real trade balance ratios, and long-term real int erest rate differentials. In particular, relative labor productivity i s statistically significant with the correct sign for more than half o f the country pairs for which cointegration is confirmed. This finding lends support to the Balassa-Samuelson productivity-bias hypothesis. These results imply that nonstationarity of real exchange rates and th e consequent rejection of simple PPP can be consistent with the notion that real exchange rates revert to an equilibrium in the long run wit hout deviating arbitrarily far from this equilibrium position. (C) 199 7 Academic Press.