Real Exchange Rates and Commodity Prices

This paper examines whether the real exchange rates of commodity-exporting developing countries move along with their commodity export earnings over time and what characteristics of an economy drive the existence of such a long-run relationship, if one exists. Focusing on 32 potential commodity-currency developing countries and using country-specific commodity indices, I find evidence for cointegrating relationships between real exchange rate and commodity price in about one third of them. In particular, this paper finds that cointegrating relationships between real exchange and commodity price are likely to exist in countries in which commodity exports are not diversified and are dominated by agricultural products. Most significantly, the median half-life of short-run real exchange rate shocks is reduced to around 15 months if the long-run movements in real exchange are determined as a function of commodity prices, supporting the view that identifying relevant real factors is the key to solving the purchasing power parity puzzle