This paper examines the persistence of real exchange rates across the world. We employ univariate time series techniques on a country-by-country basis allowing for deterministic structural breaks and nonlinearities in the adjustment process. Our findings suggest that bilateral exchange rates and industrial countries display the highest rates of persistence. We retrieve evidence indicating that higher inflation, nominal exchange rate volatility, trade openness and proximity to reference country are associated with faster rates of real exchange rate convergence. Conversely, international financial integration is only found to be a significant factor at the country group level, with differential effects across cohorts.

This paper develops a novel theory of price level differences across countries. In a model characterized by a quality hierarchy in demand, we demonstrate that GDP per capita growth leads to higher average product quality in consumption as demand shifts toward higher quality goods. In turn, such structural change in expenditure shares engenders ongoing labor reallocations toward the higher-quality goods, which are more difficult to produce, thus commanding higher prices. As a result, economic growth induces a rise in the aggregate price level of the country. As we show, this implies that countries experiencing higher relative levels of economic development observe relatively appreciated real exchange rates.

Differences in growth rates across countries imply a strong relation between factor-proportions-based trade and key aggregate economic outcomes. We construct two macro-trade datasets and illustrate that this relation is rather weak empirically. Employing a dynamic two-country model, we propose a simple explanation for this finding. By limiting the substitutability between domestic and foreign tradable varieties, the presence of intra-industry trade implies that pronounced trade specialization patterns culminate in a loss of varieties. Accordingly, intra-industry trade acts to suppress inter-industry trade dynamics, thus realigning the behavior of standard models with the empirical evidence.