An Alternative Theory of Real Exchange Rate Determination: Theory and Empirical Evidene for the Mexican Economy, 1970-2011

Abstract

This paper presents an alternative theory with regard to the Mexico-US real exchange rate. Our ap-proach takes a long term perspective and employs a classical political economy framework developed by Anwar Shaikh. Unlike mainstream theories which focus on relative consumer or producer prices, we argue that relative unit labor costs of the Mexican and US manufacturing sectors is a good indica-tor of the real exchange rate. Moreover, we explore the role of government expenditures and the net capital flows to Mexico in the determination of the real exchange rate. The empirical methods used in this paper include unit root tests and three ARDL-ECM models.