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Modeling Deviations from Purchasing Power Parity (PPP)

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Joshua Aizenman

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Abstract

The volatility of the exchange rate under floating rates can be interpreted in terms of approaches that allow for short term price rigidity as well as in terms of models that consider the magnification effect of new information. This paper combines the two approaches into a unified framework,where the degree to which prices are rigid is determined endogenously. It is shown that the variance of percentage deviations from ppp has an upper bound,and that the relationship between the variance of deviations from ppp and the aggregate variability is not monotonic. Allowing for a short-run Phillips curve with optimal indexation, it is also demonstrated that a higher price flexibility will reduce deviations from ppp and output volatility.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1066.

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Date of creation: Aug 1984
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Handle: RePEc:nbr:nberwo:1066

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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.:
  1. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December. [Downloadable!] (restricted)
  2. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April. [Downloadable!] (restricted)
  3. Logue, Dennis E & Willett, Thomas D, 1976. "A Note on the Relation between the Rate and Variability of Inflation," Economica, London School of Economics and Political Science, vol. 43(17), pages 151-58, May. [Downloadable!] (restricted)
  4. Richard C. Marston, 1982. "Wages, Relative Prices, and the Choice between Fixed and Flexible Exchange Rates," NBER Working Papers 0793, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Richard C. Marston, 1982. "Wages, Relative Prices and the Choice between Fixed and Flexible Exchange Rates," Canadian Journal of Economics, Canadian Economics Association, vol. 15(1), pages 87-103, February. [Downloadable!] (restricted)
  6. McCallum, Bennett T, 1977. "Price-Level Stickiness and the Feasibility of Monetary Stabilization Policy with Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 627-34, June. [Downloadable!] (restricted)
  7. Nancy Peregrim Marion, 1982. "The Exchange-Rate Effects of Real Disturbances with Rational Expectations and Variable Terms of Trade," Canadian Journal of Economics, Canadian Economics Association, vol. 15(1), pages 104-18, February. [Downloadable!] (restricted)
  8. Flood, Robert P & Marion, Nancy Peregrim, 1982. "The Transmission of Disturbances under Alternative Exchange-Rate Regimes with Optimal Indexing," The Quarterly Journal of Economics, MIT Press, vol. 97(1), pages 43-66, February. [Downloadable!] (restricted)
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  9. Kravis, Irving B & Heston, Alan & Summers, Robert, 1981. "New Insights into the Structure of the World Economy," Review of Income and Wealth, Blackwell Publishing, vol. 27(4), pages 339-55, December.
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  1. Irving B. Kravis & Robert E. Lipsey, 1982. "Towards an Explanation of National Price Levels," NBER Working Papers 1034, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Sebastian Edwards, 1988. "Real Exchange Rate Variability: An Empirical Analysis of the DevelopingCountries Case," NBER Working Papers 1930, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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