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Purchasing power parity and the Taylor rule

  • Masao Ogaki
  • Bruce E. Hansen
  • Ippei Fujiwara
  • Hyeongwoo Kim

It is well-known that there is a large degree of uncertainty around Rogoff's (1996) consensus half-life of the real exchange rate. To obtain a more efficient estimator, we develop a system method that combines the Taylor rule and a standard exchange rate model to estimate half-lives. Further, we propose a median unbiased estimator for the system method based on the generalized method of moments with nonparametric grid bootstrap confidence intervals. Applying the method to real exchange rates of 18 developed countries against the US dollar, we find that most half-life estimates from the single equation method fall in the range of 3 to 5 years with wide confidence intervals that extend to positive infinity. In contrast, the system method yields median-unbiased estimates that are typically shorter than one year with much sharper 95% confidence intervals. Our Monte Carlo simulation results are consistent with an interpretation of these results that the true half-lives are short but long half-life estimates from single equation methods are caused by the high degree of uncertainty of these methods.

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File URL: https://crawford.anu.edu.au/pdf/ajrc/wpapers/2013/201305.pdf
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Paper provided by Australia-Japan Research Centre, Crawford School of Public Policy, The Australian National University in its series AJRC Working Papers with number 1305.

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Length: 42 pages
Date of creation: 2013
Date of revision:
Handle: RePEc:csg:ajrcwp:1305
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Phone: (61-2) 6249 3780
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Web page: https://crawford.anu.edu.au/research_units/ajrc/
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