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The Micro-Macro Disconnect of Purchasing Power Parity

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Author Info

  • Paul R. Bergin

    (University of California at Davis and NBER)

  • Reuven Glick

    (Federal Reserve Bank of San Francisco)

  • Jyh-Lin Wu

    (National Sun Yat-Sen University)

Abstract

This paper reconciles the persistence of aggregate real exchange rates with the faster adjustment of international relative prices in microeconomic data. Error correction model estimates indicate that a different mix of shocks drives international price deviations at the microeconomic level and that dynamic adjustment works through arbitrage in the goods market rather than the foreign exchange market. When half-lives are estimated conditional on a common set of estimated macro shocks, we find that micro relative prices exhibit every bit as much persistence as aggregate real exchange rates. These results challenge theories of real exchange rate persistence based on sticky prices and heterogeneity across goods. © 2013 The President and Fellows of Harvard College and the Massachusetts Institute of Technology.

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Bibliographic Info

Article provided by MIT Press in its journal Review of Economics and Statistics.

Volume (Year): 95 (2013)
Issue (Month): 3 (July)
Pages: 798-812

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Handle: RePEc:tpr:restat:v:95:y:2013:i:3:p:798-812

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Keywords: exchange rates; prices;

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References

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  1. Jean Imbs & Haroon Mumtaz & Morton O. Ravn & Helene Rey, 2002. "PPP Strikes Back: Aggregation and the Real Exchange Rate," NBER Working Papers 9372, National Bureau of Economic Research, Inc.
  2. Parsley, David C & Wei, Shang-Jin, 1996. "Convergence to the Law of One Price without Trade Barriers or Currency Fluctuations," The Quarterly Journal of Economics, MIT Press, vol. 111(4), pages 1211-36, November.
  3. Yin-Wong Cheung & Kon S. Lai & Michael Bergman, 2003. "Dissecting the PPP Puzzle: The Unconventional Roles of Nominal Exchange Rate and Price Adjustment," CESifo Working Paper Series 924, CESifo Group Munich.
  4. Mario J. Crucini & Mototsugu Shintani, 2006. "Persistence in Law-of-One-Price Deviations: Evidence from Micro-data," Levine's Bibliography 321307000000000311, UCLA Department of Economics.
  5. Pesaran, M.H., 2003. "A Simple Panel Unit Root Test in the Presence of Cross Section Dependence," Cambridge Working Papers in Economics 0346, Faculty of Economics, University of Cambridge.
  6. Mario J. Crucini & Chris I. Telmer & Marios Zachariadis, 2005. "Understanding European Real Exchange Rates," American Economic Review, American Economic Association, vol. 95(3), pages 724-738, June.
  7. Mackowiak, Bartosz Adam & Wiederholt, Mirko, 2007. "Optimal Sticky Prices under Rational Inattention," CEPR Discussion Papers 6243, C.E.P.R. Discussion Papers.
  8. Charles Engel & James Morley, 2000. "The Adjustment of Prices and the Adjustment of the Exchange Rate," Working Papers 0009, University of Washington, Department of Economics.
  9. Shiu-Sheng Chen & Charles Engel, 2005. "Does 'Aggregation Bias' Explain The Ppp Puzzle?," Pacific Economic Review, Wiley Blackwell, vol. 10(1), pages 49-72, 02.
  10. Christian Broda & David E. Weinstein, 2008. "Understanding International Price Differences Using Barcode Data," NBER Working Papers 14017, National Bureau of Economic Research, Inc.
  11. Jon Steinsson, 2005. "The Dynamic Behavior of the Real Exchange Rate in Sticky Price Models," Economics wp28_jonst, Department of Economics, Central bank of Iceland.
  12. Jyh-Lin Wu & Pei-Fen Chen & Ching-Nun Lee, 2009. "Purchasing Power Parity, Productivity Differentials And Non-Linearity," Manchester School, University of Manchester, vol. 77(3), pages 271-287, 06.
  13. David Parsley Shang-Jin Wei, 2002. "Currency Arrangements And Goods Market Integration: A Price Based Approach," International Finance 0211004, EconWPA.
  14. M. Hashem Pesaran, 2006. "Estimation and Inference in Large Heterogeneous Panels with a Multifactor Error Structure," Econometrica, Econometric Society, vol. 74(4), pages 967-1012, 07.
  15. Charles Engel & John H. Rogers, 2004. "European product market integration after the euro," Economic Policy, CEPR & CES & MSH, vol. 19(39), pages 347-384, 07.
  16. Fisher, Eric O'N & Park, Joon Y, 1991. "Testing Purchasing Power Parity under the Null Hypothesis of Co-integration," Economic Journal, Royal Economic Society, vol. 101(409), pages 1476-84, November.
  17. Haroon Mumtaz & Jean Imbs & Morten O. Ravn & Helene Rey, 2003. "PPP Strikes Back," IMF Working Papers 03/68, International Monetary Fund.
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Citations

Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Deviations from PPP: a micro-macro disconnect?
    by Economic Logician in Economic Logic on 2010-07-21 14:22:00
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Cited by:
  1. Crucini, Mario J. & Shintani, Mototsugu & Tsuruga, Takayuki, 2013. "Do sticky prices increase real exchange rate volatility at the sector level?," European Economic Review, Elsevier, vol. 62(C), pages 58-72.
  2. Georg H. Strasser, 2011. "Exchange Rate Pass-Through and Credit Constraints: Firms Price to Market as Long as They Can," Boston College Working Papers in Economics 788, Boston College Department of Economics, revised 13 Feb 2012.

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