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Purchasing Power Parity for Traded and Non-traded Goods: A Structural Error Correction Model Approach

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  • Kim, Jaebeom

    (U St Thomas)

  • Ogaki, Masao

    (OH State U)

Abstract

When univariate methods are applied to real exchange rates, point estimates of autoregressive (AR) coefficients typically imply very slow rates of mean reversion. However, a recent study by Murray and Papell (2002) calculates confidence intervals for estimates of half-lives for long-horizon and post-1973 data, and concludes that univariate methods provide virtually no information regarding the size of the half lives. This paper estimates half-lives with a system method based on a structural error correction model for the nominal exchange rate, a domestic price index, a foreign price index, and a monetary variable. The method is applied to estimate half lives of real exchange rates based on producer price indices, consumer price indices, and GDP implicit deflators. The idea is that the traded component of the producer price index (PPI) is proportionately larger than that of the consumer price index (CPI). If the convergence rate is faster for traded goods prices than that for non-traded goods prices, half-lives for the real exchange rate based on the PPI should be shorter than those for the real exchange rate based on the CPI and that on the GDP implicit deflator. Our empirical results are consistent with this view.

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Bibliographic Info

Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

Volume (Year): 22 (2004)
Issue (Month): 1 (March)
Pages: 1-25

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Handle: RePEc:ime:imemes:v:22:y:2004:i:1:p:1-25

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Cited by:
  1. Nikolaos Giannellis & Athanasios P. Papadopoulos, 2010. "Nonlinear Exchange Rate Adjustment in the Enlarged Eurozone: Evidence and Implications for Candidate Countries," Review of International Economics, Wiley Blackwell, vol. 18(4), pages 741-757, 09.
  2. Crucini, Mario J. & Shintani, Mototsugu, 2008. "Persistence in law of one price deviations: Evidence from micro-data," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 629-644, April.
  3. Hwa-Taek Lee & Gawon Yoon, 2013. "Does purchasing power parity hold sometimes? Regime switching in real exchange rates," Applied Economics, Taylor & Francis Journals, vol. 45(16), pages 2279-2294, June.
  4. Jaebeom Kim & Masao Ogaki & Minseok Yang, 2003. "Structural Error Correction Models: Instrumental Variables Methods and an application to an exchange rate model," RCER Working Papers 502, University of Rochester - Center for Economic Research (RCER).
  5. Masao Ogaki & Bruce E. Hansen & Ippei Fujiwara & Hyeongwoo Kim, 2013. "Purchasing power parity and the Taylor rule," AJRC Working Papers 05, Australia-Japan Research Centre, Crawford School of Public Policy, The Australian National University.
  6. Masao Ogaki & Sungwook Park, 2007. "Long-run real exchange rate changes and the properties of the variance of k-differences," Working Papers 07-05, Ohio State University, Department of Economics.

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