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Modeling the real exchange rate: looking for evidence of the wage-share effect

Verónica De Jesús Romo and Julio López Gallardo

Keywords: real exchange rate; income distribution; cointegrated VAR; labor productivity; interest rates; Mexico; France; South Korea

In this paper we study the determinants of the real exchange rate (RER), analysing in particular its association with the share of wages in output. We model the behavior of the RER against the US dollar of the domestic currency of three countries: Mexico, Korea, and France. We specify econometric vector autoregression (VAR) models and find for each country a long-run relation for the RER. In the three cases, we identify a negative association between the RER and the wage share and the RER, and the difference between the domestic and the US nominal interest rate. We also find that the RER is positively associated with labor productivity in Korea and France, but negatively associated in Mexico. We then suggest theoretical reasons for the type of associations found. As a corollary, we discuss the reasons that may explain why the RER tends to return to a long-run ‘normal’ value.

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