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PPP Strikes Back: Aggregation and the Real Exchange Rate

  • Jean Imbs

    ()

    (Centre for Economic Policy Research)

  • Haroon Mumtaz

    ()

    (London Business School)

  • Morten O. Ravn

    ()

    (Centre for Economic Policy Research)

  • Helene Rey

    ()

    (Centre for Economic Policy Research)

We show the importance of a dynamic aggregation bias in accounting for the PPP puzzle. We prove that established time series and panel methods substantially exaggerate the persistence of real exchange rates because of heterogeneity in the dynamics of disaggregated relative prices. When heterogeneity is properly taken into account, estimates of the real exchange rate half-life fall dramatically, to little more than one year, or significantly below Rogoff’s ‘consensus view’ of three to five years. We show that corrected estimates are consistent with plausible nominal rigidities, thus, arguably, solving the PPP puzzle.

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Paper provided by Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences in its series IEHAS Discussion Papers with number 0307.

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Length: 57 pages
Date of creation: Jun 2003
Date of revision:
Handle: RePEc:has:discpr:0307
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