A REASSESSMENT OF THE RELATIONSHIP BETWEEN REAL EXCHANGE-RATES AND REAL INTEREST-RATES - 1974-1990

This paper uses cointegration techniques and error-correction models to re-examine the link between real exchange rates and real interest rate differentials. The results show that real exchange rates and real interest rates are nonstationary; however, they are not cointegrated with each other. On the other hand, the dynamic models indicate that there might be a long-run relationship between these variables, but this cannot be verified. The final conclusion is that there is little empirical evidence in support of a systematic relationship, and this result is robust across exchange rates, time periods, and measures of expected inflation.