Sources of real exchange rate fluctuations in the Nordic countries

In an attempt to move beyond the purchasing power parity hypothesis, this paper addresses two issues. The first concerns the causes of movements in real exchange rates. In contrast to the typical result, supply shocks are found to dominate the long-run variance decompositions for each of the four Nordic countries under study. This suggests that productivity developments are the most important determinant of long-run movements in real exchange rates. 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.