| Both nominal and real exchange rates have fluctuated widely during the recent floating period, implying that purchasing power parity (PPP) does not hold at all times. As a result, it is important to determine whether exchange rates can be modeled in a PPP framework and, if not, how the resultant models can be altered to allow for PPP deviations or slow reversion back to parity. These topics serve as the backdrop to this dissertation.; The first chapter of this dissertation presents a definition of the equilibrium exchange rate that is based on a modified version of purchasing power parity for traded goods. Employing CES production functions and data from 28 three-digit ISIC manufacturing industries, the equilibrium yen-dollar rate is calculated for 1976--1991, and it is shown that the actual yen-dollar rate tracks the equilibrium rate closely over the time period. The results suggest that strong growth in Japanese labor productivity coupled with Japan's relatively low capital-labor elasticity of substitution were the main contributors to the yen's long-run appreciation relative to the dollar.; The second chapter introduces a small-country equilibrium exchange rate model that is driven predominantly by real factors. Using cointegration/error correction techniques, the study shows that a long-run equilibrium relationship holds between real and nominal exchange rates and home and foreign productivity growth, the home-foreign terms of trade differential, and commercial policy. The results lend support to the model introduced in the paper.; Building on the Dixit-Stiglitz framework of product differentiation, the third and final chapter derives a model of exchange rate pass-through and employs it to predict the persistence of sectoral real exchange rates across 14 OECD countries. Using almost three decades of annual data on industry-specific variables, the paper finds that real sectoral exchange rate reversion is explained primarily by wage adjustment and input shares of output, suggesting that the labor market may deserve more recognition as a channel through which deviations from purchasing power parity decay. |
