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The Roles of Nominal Exchange Rate and Relative Price Adjustments in PPP Reversion

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  • DEOKWOO NAM

Abstract

This paper investigates the roles of the nominal exchange rate and relative prices in restoring purchasing power parity (PPP) by estimating their dynamics with a bivariate threshold vector error correction model. Our empirical results suggest a threshold cointegrating relationship between the nominal exchange rate and relative prices. However, these two variables play different roles in restoring PPP. The nominal exchange rate adjusts to restore PPP only outside the threshold band. Within the band, PPP is restored mainly through adjustments in relative prices.

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  • Deokwoo Nam, 2011. "The Roles of Nominal Exchange Rate and Relative Price Adjustments in PPP Reversion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(4), pages 775-785, June.
    • Handle: RePEc:wly:jmoncb:v:43:y:2011:i:4:p:775-785
    DOI: 10.1111/j.1538-4616.2011.00396.x
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