Real exchange rate dynamics under the current float: A re-examination

Augmented Dickey-Fuller regressions on pooled (but not individual) real exchange rates for the post-1973 period consistently reject the unit root null, even after accounting for cross-sectional dependence. The inference that the series is stationary, however, is not necessarily correct, because these tests strongly over-reject the null in certain circumstances, particularly when the series has a stochastic unit root. We find that bilateral real exchange rates against the US dollar have a stochastic unit root. Out-of-sample prediction exercises for an autoregressive model confirm these findings.