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The micro-macro disconnect of purchasing power parity

Author

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  • Paul R. Bergin
  • Reuven Glick
  • Jyh-Lin Wu

Abstract

The persistence of aggregate real exchange rates is a prominent puzzle, particularly since adjustment of international relative prices in microeconomic data is much faster. This paper finds that adjustment to the law of one price in disaggregated data is not just a faster version of the adjustment to purchasing power parity in the aggregate data; while aggregate real exchange rate adjustment works primarily through the foreign exchange market, adjustment in disaggregated data is a qualitatively distinct process, working through adjustment in local-currency goods prices. These distinct adjustment dynamics appear to arise from distinct classes of shocks generating macro and micro price deviations. A vector error correction model nesting aggregate and disaggregated relative prices permits identification of distinct macroeconomic and good-specific shocks. When half-lives are estimated conditional on shocks, the macro-micro disconnect puzzle disappears: microeconomic relative prices adjust to macro shocks just as slowly as do aggregate real exchange rates. These results provide evidence against theories of real exchange rate behavior based on sticky prices and on heterogeneity across goods.

Suggested Citation

  • Paul R. Bergin & Reuven Glick & Jyh-Lin Wu, 2010. "The micro-macro disconnect of purchasing power parity," Working Paper Series 2010-14, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfwp:2010-14
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    References listed on IDEAS

    as
    1. Christian Broda & David E. Weinstein, 2008. "Understanding International Price Differences Using Barcode Data," NBER Working Papers 14017, National Bureau of Economic Research, Inc.
    2. Jean Imbs & Haroon Mumtaz & Morten O. Ravn & Hélène Rey, 2005. "PPP Strikes Back: Aggregation And the Real Exchange Rate," The Quarterly Journal of Economics, Oxford University Press, vol. 120(1), pages 1-43.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Deviations from PPP: a micro-macro disconnect?
      by Economic Logician in Economic Logic on 2010-07-21 19:22:00

    Citations

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    Cited by:

    1. Andrade, Philippe & Zachariadis, Marios, 2016. "Global versus local shocks in micro price dynamics," Journal of International Economics, Elsevier, vol. 98(C), pages 78-92.
    2. Bergin, Paul R. & Glick, Reuven & Wu, Jyh-Lin, 2014. "Mussa redux and conditional PPP," Journal of Monetary Economics, Elsevier, vol. 68(C), pages 101-114.
    3. Bergin, Paul R. & Glick, Reuven & Wu, Jyh-Lin, 2017. "“Conditional PPP” and real exchange rate convergence in the euro area," Journal of International Money and Finance, Elsevier, vol. 73(PA), pages 78-92.
    4. Strasser, Georg, 2013. "Exchange rate pass-through and credit constraints," Journal of Monetary Economics, Elsevier, vol. 60(1), pages 25-38.
    5. Michele Ca’ Zorzi & Jakub Muck & Michal Rubaszek, 2016. "Real Exchange Rate Forecasting and PPP: This Time the Random Walk Loses," Open Economies Review, Springer, vol. 27(3), pages 585-609, July.
    6. repec:eee:ecolet:v:158:y:2017:i:c:p:62-66 is not listed on IDEAS
    7. Crucini, Mario J. & Shintani, Mototsugu & Tsuruga, Takayuki, 2013. "Do sticky prices increase real exchange rate volatility at the sector level?," European Economic Review, Elsevier, vol. 62(C), pages 58-72.
    8. Daniel M. Bernhofen & Markus Eberhardt & Jianan Li & Stephen Morgan, 2015. "Assessing Market (Dis)Integration in Early Modern China and Europe," CESifo Working Paper Series 5580, CESifo Group Munich.
    9. Ca’ Zorzi, Michele & Kolasa, Marcin & Rubaszek, Michał, 2017. "Exchange rate forecasting with DSGE models," Journal of International Economics, Elsevier, pages 127-146.
    10. M. Ege Yazgan & Hakan Yilmazkuday, 2016. "High versus low inflation: implications for price-level convergence," Empirical Economics, Springer, pages 1527-1563.
    11. Marina Glushenkova & Andros Kourtellos & Marios Zachariadis, 2016. "Barriers to price convergence," University of Cyprus Working Papers in Economics 02-2016, University of Cyprus Department of Economics.
    12. Nicolas Cachanosky, 2014. "The Mises-Hayek business cycle theory, fiat currencies and open economies," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 27(3), pages 281-299, September.

    More about this item

    Keywords

    Foreign exchange rates ; Purchasing power parity ; Prices;

    JEL classification:

    • F00 - International Economics - - General - - - General
    • F15 - International Economics - - Trade - - - Economic Integration
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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