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PPP Strikes Back: Aggregation And the Real Exchange Rate

Author

Listed:
  • Jean Imbs
  • Haroon Mumtaz
  • Morten O. Ravn
  • Hélène Rey

Abstract

We show the importance of a dynamic aggregation bias in accounting for the PPP puzzle. We prove that the aggregate real exchange rate is persistent because its components have heterogeneous dynamics. Established time series and panel methods fail to control for this. Using Eurostat data, we find that when heterogeneity is taken into account, the estimated persistence of real exchange rates falls dramatically. Its half-life, for instance, may fall to as low as eleven months, significantly below the "consensus view" of three to five years.

Suggested Citation

  • Jean Imbs & Haroon Mumtaz & Morten O. Ravn & Hélène Rey, 2005. "PPP Strikes Back: Aggregation And the Real Exchange Rate," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 120(1), pages 1-43.
    • Handle: RePEc:oup:qjecon:v:120:y:2005:i:1:p:1-43.
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    JEL classification:

    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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