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Purchasing Power Disparity During the Floating Rate Period: Exchange Rate Volatility, Trade Barriers and Other Culprits

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  • Shang-Jin Wei
  • David C. Parsley

Abstract

Using a panel of 12 tradable sectors in 91 OECD country pairs (14 countries), we study the deviations from the purchasing power parity during the recent floating exchange rate period. (1) We find some evidence that the deviations are positively related to exchange rate volatility as well as to transportation costs. (2) Once we have controlled for these two factors, free trade areas such as the EC and the EFTA do not seem to reduce significantly the deviations from PPP relative to other OECD countries. (3) Although only using the post- 1973 data, we are able to find strong evidence of mean reversion towards PPP. The estimated half lives of the deviation from PPP are about four years and three quarters for the non-EMS countries in the sample, and four years and one quarter for the EMS countries. (4) We find evidence of non-linearity in the rate of mean reversion: the convergence occurs faster for country pairs with larger initial deviations.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5032.

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Date of creation: Feb 1995
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Handle: RePEc:nbr:nberwo:5032

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  1. Kenneth Rogoff, 1992. "Traded Goods Consumption Smoothing and the Random Walk Behavior of the Real Exchange Rate," NBER Working Papers 4119, National Bureau of Economic Research, Inc.
  2. Engel, C. & Rogers, J.H., 1995. "How Wide is the Border?," Papers, Pennsylvania State - Department of Economics 4-95-16, Pennsylvania State - Department of Economics.
  3. Holger C. Wolf & Alberto Giovannini & Jose De Gregorio, 1994. "International Evidenceon Tradables and Nontradables Inflation," IMF Working Papers 94/33, International Monetary Fund.
  4. Kenneth A. Froot & Kenneth Rogoff, 1994. "Perspectives on PPP and Long-Run Real Exchange Rates," NBER Working Papers 4952, National Bureau of Economic Research, Inc.
  5. Jeffrey A. Frankel & Shang-Jin Wei, 1993. "Emerging Currency Blocs," NBER Working Papers 4335, National Bureau of Economic Research, Inc.
  6. Lothian, James R & Taylor, Mark P, 1996. "Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 104(3), pages 488-509, June.
  7. 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.
  8. Kenneth A. Froot & Kenneth Rogoff, 1991. "The EMS, the EMU, and the Transition to a Common Currency," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 269-328 National Bureau of Economic Research, Inc.
  9. Jeffrey A. Frankel, 1985. "International capital mobility and crowding-out in the U.S. economy: imperfect integration of financial markets or of goods markets?," Proceedings, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, pages 33-74.
  10. Atish R. Ghosh & Holger C. Wolf, 1994. "Pricing in International Markets: Lessons from The Economist," Working Papers, New York University, Leonard N. Stern School of Business, Department of Economics 94-21, New York University, Leonard N. Stern School of Business, Department of Economics.
  11. Edison, Hali J, 1987. "Purchasing Power Parity in the Long Run: A Test of the Dollar/Pound Exchange Rate (1890-1978)," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 19(3), pages 376-87, August.
  12. Jeffrey A. Frankel & Ernesto Stein & Shang-Jin Wei, 1993. "Continental Trading Blocs: Are They Natural, or Super-Natural?," NBER Working Papers 4588, National Bureau of Economic Research, Inc.
  13. Genberg, Hans, 1978. "Purchasing power parity under fixed and flexible exchange rates," Journal of International Economics, Elsevier, Elsevier, vol. 8(2), pages 247-276, May.
  14. Papell, David H, 1994. "Exchange Rates and Prices: An Empirical Analysis," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 35(2), pages 397-410, May.
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