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Purchasing power parity, wages and inflation in emerging markets

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  • Goyal, Ashima

    ()
    (Indira Gandhi Institute of Development Research)

Abstract

Persistent deviation of real exchange rates from purchasing power parity (PPP) values is a puzzle, since nominal shocks, which cause such deviation, are expected to have only short-run effects. If some goods are non-traded, Balassa Samuelson (BS) showed how such deviations occur and explain why the price level is relatively higher in advanced economies. But then, consistently higher inflation in emerging or developing economies (EDE) is another puzzle. The paper presents a framework giving a new simple proof of the BS result. If the assumption that the price level is fixed for the EDE is dropped, nominal depreciation interacting with different types of wage rigidities can explain higher inflation, as nominal wages rise in response to a nominal depreciation. Then monetary shocks have persistent effects but these shocks can arise from large capital flows independent of changes in domestic money supply. Evidence from India supports the hypotheses.

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Bibliographic Info

Paper provided by Indira Gandhi Institute of Development Research, Mumbai, India in its series Indira Gandhi Institute of Development Research, Mumbai Working Papers with number 2012-025.

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Length: 24 pages
Date of creation: Nov 2012
Date of revision:
Handle: RePEc:ind:igiwpp:2012-025

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Keywords: Purchasing power parity; inflation differentials; wage rigidities;

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  1. Ashima Goyal, . "Inflationary Pressures in South Asia," MPDD Working Paper Series, United Nations Economic and Social Commission for Asia and the Pacific (ESCAP) WP/11/14, United Nations Economic and Social Commission for Asia and the Pacific (ESCAP).
  2. Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 72, pages 584.
  3. Summers, Robert & Heston, Alan, 1991. "The Penn World Table (Mark 5): An Expanded Set of International Comparisons, 1950-1988," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 106(2), pages 327-68, May.
  4. Bhagwati, Jagdish N, 1984. "Why Are Services Cheaper in the Poor Countries?," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 94(374), pages 279-86, June.
  5. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 34(2), pages 647-668, June.
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