| Summary: | This thesis investigates the drivers of real exchange rates, their theoretical modelling
implications, and their forecasting power for nominal exchange rates. The first
chapter provides a brief introduction to this thesis. Chapter 2 goes on to present
empirical evidence that the debate around drivers of real exchange rates should
not exclusively focus on tradable and non-tradable goods’ prices but also take into
account two additional terms: the relative distribution cost, and the relative profit
margins in the two economies. The results yield two conclusions: first, these factors
account for a large proportion of real exchange rate variations. Second, the margin
estimates from the top-down approach considered here compare well with micro
data estimates from the literature. Chapter 3 takes these results to the theoretical
literature to test under which assumptions current macroeconomic models can
replicate this empirical finding. The results show that broadly similar dynamics to
those observed in the data can be obtained from a two-country open economy model
with local currency pricing, tradable and non-tradable goods, and a distribution
sector. Chapter 4 then tests whether the distribution real exchange rate can be a
helpful predictor for nominal exchange rates at a number of different horizons. The
results show that forecast performance can be improved by using the distribution
margin real exchange rate, especially at longer horizons. The distribution real
exchange rate, however, only improves forecast performance at the one-quarter
ahead horizon a little, a conclusion in line with the existing literature.
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