In this paper we use a Threshold AutoRegressive (TAR) model to capture thenonlinear dynamics of monthly real effective exchange rate data for the G7countries. The novelty of our approach relates to the use of the realinterest differential as the switching variable. This choice allows us toconsider jointly the nonlinearity and nonstationarity issues using recentadvances in asymptotic theory. We find that the null of linearity is easilyrejected against the nonlinear model for all currencies considered. Further,for five out of the seven countries, where the null of unit root isrejected, we report evidence of quite rapid mean reversion.
