DP3376 The Real Exchange Rate Always Floats

Author(s): Thorvaldur Gylfason
Publication Date: May 2002
Keyword(s): flexible exchange rates
JEL(s): F31
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3376

This Paper makes two main points. First, irrespective of nominal exchange rate arrangements, the real exchange rate always floats ? if not through nominal exchange rate adjustment, then through price change. Further, because prices and wages tend to be sticky, the adjustment of real exchange rates towards long-run equilibrium takes time, as witnessed by long-lasting currency misalignments around the world. Second, real exchange rates are likely to fluctuate on their way towards long-run equilibrium because of the dynamic interaction between real exchange rates and the current account; or, put differently, because the structure of lags with which exchange rates impact the volume of exports and imports may give rise to oscillatory behaviour.