Oil prices and real exchange rates

In this paper, we investigate the long-run relationship between real oil prices and real exchange rates by using a monthly panel of G7 countries from 1972:1 to 2005:10. We first test whether exchange rates are cointegrated with real oil prices. It is shown that real oil prices may have been the dominant source of real exchange rate movements and that there is a link between real oil prices and real exchange rates. We then examine the ability of real oil prices to forecast future real exchange returns. Panel predictive regression estimates suggest that real oil prices have significant forecasting power. The out-of-sample prediction performances demonstrate greater predictability over longer horizons.