Advanced Search
MyIDEAS: Login to save this paper or follow this series

The Micro-foundations of Big Mac Real Exchange Rates

Contents:

Author Info

  • David C. Parsley

    ()
    (Vanderbilt University)

  • Shang-Jin Wei

    ()
    (International Monetary Fund Brookings Institution)

Abstract

The real exchange rate is said to be the single most important price in an economy. While we used to think that we knew what explained its movements (e.g., the Balassa-Samuelson effect), the recent much-cited result by Engel (1999) proposes a serious reinterpretation – i.e., nearly 100% of the movements in the U.S. real exchange rate are explained by deviations from the law of one price. Engel’s finding holds even in the medium run, when movements in the relative price of non-tradables between countries, were thought to be of paramount importance. In this project, we study the movement of real exchange rates based on the prices of Big Macs (which we show are highly correlated with the CPIbased real exchange rates). Our main innovation is to match these prices to the prices of individual ingredients (ground beef, bread, lettuce, labor cost, rent, etc.) in 34 countries during 1990–2002. There are a number of advantages associated with our approach. First, unlike the CPI real exchange rate, we can measure the Big Mac real exchange rate in levels in an economically meaningful way. Second, unlike the CPI real exchange rate for which the attribution to tradable and non-tradable components involves assumptions on the weights and the functional form, we (almost) know the exact composition of a Big Mac, and can estimate the tradable and non-tradable components relatively precisely. Third, we can study the dynamics of the real exchange rate in a setting that is free of the productaggregation bias (argued by Imbs, Mumtaz, Ravn, and Rey, 2002, to be important in studies on CPI real exchange rates), the temporal aggregation bias (argued to be important by Taylor, 2001), or the bias generated by non-compatible consumption baskets across countries. Fourth, we show that Engel's result that deviation from the law of one price is all that matters does not hold generally. Furthermore, deviations from his result can be systematically explained.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://econ.core.hu/doc/dp/dp/mtdp0306.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences in its series IEHAS Discussion Papers with number 0306.

as in new window
Length: 48 pages
Date of creation: Jun 2003
Date of revision:
Handle: RePEc:has:discpr:0306

Contact details of provider:
Postal: 1112 Budapest, Budaorsi ut 45.
Phone: (+36-1) 309-2652
Fax: (36-1) 319-3136
Web page: http://econ.core.hu
More information through EDIRC

Related research

Keywords: Real exchange rates; TAR models;

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Paul G. J. O'Connell & Shang-Jin Wei, 1997. ""The Bigger They Are, The Harder They Fall": How Price Differences Across U.S. Cities Are Arbitraged," NBER Working Papers 6089, National Bureau of Economic Research, Inc.
  2. David C. Parsley, 2001. "Accounting for Real Exchange Rate Changes in East Asia," Working Papers 062001, Hong Kong Institute for Monetary Research.
  3. Engel, Charles & Rogers, John H, 1996. "How Wide Is the Border?," American Economic Review, American Economic Association, vol. 86(5), pages 1112-25, December.
  4. Froot, Kenneth A. & Rogoff, Kenneth, 1995. "Perspectives on PPP and long-run real exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 32, pages 1647-1688 Elsevier.
  5. 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.
  6. Michael R. Pakko & Patricia S. Pollard, 1996. "For here or to go? Purchasing power parity and the Big Mac," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 3-22.
  7. David C. Parsley & Shang-Jin Wei, 2000. "Explaining the Border Effect: The Role of Exchange Rate Variability, Shipping Costs, and Geography," NBER Working Papers 7836, National Bureau of Economic Research, Inc.
  8. 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.
  9. Rose, Andrew, 1999. "One Money, One Market: Estimating the Effect of Common Currencies on Trade," Seminar Papers 678, Stockholm University, Institute for International Economic Studies.
  10. Charles Engel, 1999. "Accounting for U.S. Real Exchange Rate Changes," Journal of Political Economy, University of Chicago Press, vol. 107(3), pages 507-538, June.
  11. Kenneth Froot & Kenneth Rogoff & Olivier Blanchard & Stanley Fischer, . "The EMS, the EMU, and the Transition to a Common Currency," Working Paper 32216, Harvard University OpenScholar.
  12. Puumanen, Kari, 1989. " Real Exchange Rates and Macroeconomics: A Selective Survey," Scandinavian Journal of Economics, Wiley Blackwell, vol. 91(2), pages 433-34.
  13. Enrique G. Mendoza, 2000. "On the Instability of Variance Decompositions of the Real Exchange Rate across Exchange-Rate-Regimes: Evidence from Mexico and the United States," NBER Working Papers 7768, National Bureau of Economic Research, Inc.
  14. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  15. Dornbusch, Rudiger, 1989. " Real Exchange Rates and Macroeconomics: A Selective Survey," Scandinavian Journal of Economics, Wiley Blackwell, vol. 91(2), pages 401-32.
  16. Ong, Li Lian, 1997. "Burgernomics: the economics of the Big Mac standard," Journal of International Money and Finance, Elsevier, vol. 16(6), pages 865-878, December.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Thomas Mathä, 2009. "Regional Mc parity: do common pricing points reduce deviations from the law of one price?," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 145(1), pages 155-166, April.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:has:discpr:0306. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Adrienn Foldi).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.