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Persistent gaps between purchasing power parities and exchange rates under the law of one price: a puzzle (partly) explained?

Listed author(s):
  • Leon Podkaminer

    ()

    (The Vienna Institute for International Economic Studies)

Simple general equilibrium (exchange) models of intra-EU trade generate equalized relative prices of consumer tradables. Simultaneously, more dispersed domestic relative prices of consumer non-tradables are generated. Consequently, the purchasing power parity/exchange rate ratios may move further away from unity. The PPP/ER discrepancies may widen even when there are no impediments to free trade. While the models force the relative prices of tradables into uniformity, in reality these prices are persistently dispersed across countries. This does not vitiate the law of one price though. The retail prices of tradables depend also on prices of the local (non-tradable) inputs (e.g. distribution services). Prices of tradables net of costs of services (unobservable) may tend to obey the law of one price. The observed (retail) prices of tradables may not show this tendency even under free and competitive foreign trade because such a trade can widen the gaps between prices of non-tradables internationally.

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Article provided by Narodowy Bank Polski in its journal Bank i Kredyt.

Volume (Year): 44 (2013)
Issue (Month): 4 ()
Pages: 333-352

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Handle: RePEc:nbp:nbpbik:v:44:y:2013:i:4:p:333-352
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  1. James E. Anderson & Eric van Wincoop, 2004. "Trade Costs," Journal of Economic Literature, American Economic Association, vol. 42(3), pages 691-751, September.
  2. Leon Podkaminer, 2004. "Why is food cheaper in rich (European) countries?," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 57(230), pages 297-327.
  3. Leon Podkaminer, 2010. "Why Are Goods Cheaper in Rich Countries? Beyond the Balassa-Samuelson Effect," wiiw Working Papers 64, The Vienna Institute for International Economic Studies, wiiw.
  4. Christian Dreger & Konstantin Kholodilin & Kirsten Lommatzsch & Jiri Slacalek & Przemyslaw Wozniak, 2007. "Price Convergence in the Enlarged Internal Market," Discussion Papers of DIW Berlin 730, DIW Berlin, German Institute for Economic Research.
  5. De Gregorio, Jose & Giovannini, Alberto & Wolf, Holger C., 1994. "International evidence on tradables and nontradables inflation," European Economic Review, Elsevier, vol. 38(6), pages 1225-1244, June.
  6. Mario J. Crucini & Chris I. Telmer & Marios Zachariadis, 2005. "Understanding European Real Exchange Rates," American Economic Review, American Economic Association, vol. 95(3), pages 724-738, June.
  7. Hisham Foad, 2005. "Europe Without Borders? The Effect of the EMU on Relative Prices," Emory Economics 0515, Department of Economics, Emory University (Atlanta).
  8. Lucio Sarno, 2005. "Viewpoint: Towards a solution to the puzzles in exchange rate economics: where do we stand?," Canadian Journal of Economics, Canadian Economics Association, vol. 38(3), pages 673-708, August.
  9. Alan M. Taylor & Mark P. Taylor, 2004. "The Purchasing Power Parity Debate," Journal of Economic Perspectives, American Economic Association, vol. 18(4), pages 135-158, Fall.
  10. Méjean, Isabelle & Schwellnus, Cyrille, 2009. "Price convergence in the European Union: Within firms or composition of firms?," Journal of International Economics, Elsevier, vol. 78(1), pages 1-10, June.
  11. Clements, Kenneth W & Selvanathan, Saroja, 1994. "Understanding Consumption Patterns," Empirical Economics, Springer, vol. 19(1), pages 69-110.
  12. Leon Podkaminer, 2003. "Analytical notes on the Balassa-Samuelson effect," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 56(226), pages 207-221.
  13. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters,in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412 National Bureau of Economic Research, Inc.
  14. Burstein, Ariel T. & Neves, Joao C. & Rebelo, Sergio, 2003. "Distribution costs and real exchange rate dynamics during exchange-rate-based stabilizations," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1189-1214, September.
  15. Hisham Foad, 2010. "Europe Without Borders? The Effect of the Euro on Price Convergence," International Regional Science Review, , vol. 33(1), pages 86-111, January.
  16. Campa, Jose Manuel & Gonzalez Minguez, Jose M., 2006. "Differences in exchange rate pass-through in the euro area," European Economic Review, Elsevier, vol. 50(1), pages 121-145, January.
  17. Podkaminer, Leon, 1982. "Estimates of the Disequilibria in Poland's Consumer Markets, 1965-1978," The Review of Economics and Statistics, MIT Press, vol. 64(3), pages 423-431, August.
  18. Joanna Wolszczak-Derlacz & Rembert De Blander, 2009. "Price convergence in the European Union and in the New Member States," Bank i Kredyt, Narodowy Bank Polski, vol. 40(2), pages 37-59.
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