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The Purchasing Power Parity Debate

  • Alan M. Taylor
  • Mark Taylor

    (Department of Economics, University of California Davis)

Originally propounded by the sixteenth-century scholars of the University of Salamanca, the conceptof purchasing power parity (PPP) was revived in the interwar period in the context of the debateconcerning the appropriate level at which to re-establish international exchange rate parities.Broadly accepted as a long-run equilibrium condition in the post-war period, it first was advocatedas a short-run equilibrium by many international economists in the first few years following thebreakdown of the Bretton Woods system in the early 1970s and then increasingly came under attackon both theoretical and empirical grounds from the late 1970s to the mid 1990s. Accordingly, overthe last three decades, a large literature has built up that examines how much the data deviated fromtheory, and the fruits of this research have provided a deeper understanding of how well PPP appliesin both the short run and the long run. Since the mid 1990s, larger datasets and nonlineareconometric methods, in particular, have improved estimation. As deviations narrowed between realexchange rates and PPP, so did the gap narrow between theory and data, and some degree ofconfidence in long-run PPP began to emerge again. In this respect, the idea of long-run PPP nowenjoys perhaps its strongest support in more than thirty years, a distinct reversion in economic thought.

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Paper provided by University of California, Davis, Department of Economics in its series Working Papers with number 46.

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Length: 35
Date of creation: 01 Jun 2004
Date of revision:
Handle: RePEc:cda:wpaper:04-6
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  1. Obstfeld, Maurice, 2001. "International Macroeconomics: Beyond the Mundell-Fleming Model," Center for International and Development Economics Research, Working Paper Series qt6796n8s0, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
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  4. Engel, Charles, 2000. "Long-run PPP may not hold after all," Journal of International Economics, Elsevier, vol. 51(2), pages 243-273, August.
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  7. Lutz Kilian & Mark P. Taylor, 2001. "Why Is It So Difficult to Beat the Random Walk Forecast of Exchange Rates?," Working Papers 464, Research Seminar in International Economics, University of Michigan.
  8. Abuaf, Niso & Jorion, Philippe, 1990. " Purchasing Power Parity in the Long Run," Journal of Finance, American Finance Association, vol. 45(1), pages 157-74, March.
  9. Yin-Wong Cheung & Menzie D. Chinn & Eiji Fujii, 1999. "Market Structure and the Persistence of Sectoral Real Exchange Rates," NBER Working Papers 7408, National Bureau of Economic Research, Inc.
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  11. Obstfeld, Maurice & Taylor, Alan M., 1997. "Nonlinear Aspects of Goods-Market Arbitrage and Adjustment: Heckscher's Commodity Points Revisited," Journal of the Japanese and International Economies, Elsevier, vol. 11(4), pages 441-479, December.
  12. Flood, R.P. & Rose, A.K., 1992. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," Papers 529, Stockholm - International Economic Studies.
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  14. Mark P. Taylor & Lucio Sarno, 2004. "International real interest rate differentials, purchasing power parity and the behaviour of real exchange rates: the resolution of a conundrum," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 9(1), pages 15-23.
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  25. Papell, David H., 1997. "Searching for stationarity: Purchasing power parity under the current float," Journal of International Economics, Elsevier, vol. 43(3-4), pages 313-332, November.
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  27. Sercu, Piet & Uppal, Raman & Van Hulle, Cynthia, 1995. " The Exchange Rate in the Presence of Transaction Costs: Implications for Tests of Purchasing Power Parity," Journal of Finance, American Finance Association, vol. 50(4), pages 1309-19, September.
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  29. Taylor, Mark P. & McMahon, Patrick C., 1988. "Long-run purchasing power parity in the 1920s," European Economic Review, Elsevier, vol. 32(1), pages 179-197, January.
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