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Purchasing Power Parity and New Trade Theory

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  • Luca A Ricci
  • Ronald MacDonald

Abstract

This paper theoretically derives and empirically tests the implications of a new trade theory framework for the systematic movements in the real exchange rate. It focuses on the effect of imperfect substitutability of tradables and on the importance of competitiveness, for which we construct an original proxy. Using a panel dynamic OLS estimation of nine bilateral US dollar real exchange rates, we derive long-run coefficients for relative productivity and competitiveness in the tradable and non-tradable sectors, controlling for standard macroeconomic variables. The implications of imperfect substitutability of tradables fit the data better than the standard neoclassical assumption of price equalization. Our new measure of competitiveness is statistically significant in explaining deviations from PPP.

Suggested Citation

  • Luca A Ricci & Ronald MacDonald, 2002. "Purchasing Power Parity and New Trade Theory," IMF Working Papers 02/32, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:02/32
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    References listed on IDEAS

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    Cited by:

    1. Kirsten Lommatzsch & Silke Tober, 2006. "Euro-Area Inflation: does the Balassa–Samuelson effect matter?," International Economics and Economic Policy, Springer, vol. 3(2), pages 105-136, November.
    2. Stokke, Hildegunn E., 2008. "Resource boom, productivity growth and real exchange rate dynamics -- A dynamic general equilibrium analysis of South Africa," Economic Modelling, Elsevier, vol. 25(1), pages 148-160, January.
    3. Egert, Balazs, 2005. "Equilibrium exchange rates in South Eastern Europe, Russia, Ukraine and Turkey: Healthy or (Dutch) diseased?," Economic Systems, Elsevier, vol. 29(2), pages 205-241, June.
    4. Egert, Balazs & Lommatzsch, Kirsten & Lahreche-Revil, Amina, 2006. "Real exchange rates in small open OECD and transition economies: Comparing apples with oranges?," Journal of Banking & Finance, Elsevier, vol. 30(12), pages 3393-3406, December.
    5. Lukasz Rawdanowicz, 2003. "The EMU Enlargement and the Choice of the Euro Conversion Rates: Theoretical and Empirical Issues," CASE Network Studies and Analyses 0269, CASE-Center for Social and Economic Research.
    6. Fabio Ghironi & Marc J. Melitz, 2005. "International Trade and Macroeconomic Dynamics with Heterogeneous Firms," The Quarterly Journal of Economics, Oxford University Press, vol. 120(3), pages 865-915.
    7. Ronald MacDonald & Luca A Ricci, 2001. "PPP and the Balassa Samuelson Effect; The Role of the Distribution Sector," IMF Working Papers 01/38, International Monetary Fund.
    8. repec:onb:oenbwp:y::i:106:b:1 is not listed on IDEAS
    9. Balazs Egert & Amina Lahrèche-Révil & Kirsten Lommatzsch, 2004. "The Stock-Flow Approach to the Real Exchange Rate of CEE Transition Economies," Working Papers 2004-15, CEPII research center.
    10. Balázs Égert & László Halpern & Ronald MacDonald, 2006. "Equilibrium Exchange Rates in Transition Economies: Taking Stock of the Issues ," Journal of Economic Surveys, Wiley Blackwell, vol. 20(2), pages 257-324, April.
    11. Apte, Prakash & Sercu, Piet & Uppal, Raman, 2004. "The exchange rate and purchasing power parity: extending the theory and tests," Journal of International Money and Finance, Elsevier, vol. 23(4), pages 553-571, June.
    12. Balazs Egert & Carol Leonard, 2008. "Dutch Disease Scare in Kazakhstan: Is it real?," Open Economies Review, Springer, vol. 19(2), pages 147-165, April.
    13. Mariam Camarero & Javier Ordóñez & Cecilio Tamarit, 2002. "The Euro-Dollar Exchange Rate: Is it Fundamental?," CESifo Working Paper Series 798, CESifo Group Munich.
    14. Balázs Égert, 2012. "Dutch diease in the post-soviet countries of central and south-west Asia: How contagious is it?," Post-Print hal-01385841, HAL.
    15. Ian Babetskii & Balázs Égert, 2005. "Equilibrium Exchange Rate in the Czech Republic: How Good is the Czech BEER?," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 55(5-6), pages 232-252, May.
    16. Dhaneshwar Ghura & Rina Bhattacharya, 2006. "Oil and Growth in the Republic of Congo," IMF Working Papers 06/185, International Monetary Fund.
    17. Balázs Égert, 2009. "Dutch Disease in Former Soviet Union: Witch-Hunting," CASE Network Studies and Analyses 0380, CASE-Center for Social and Economic Research.
    18. Balázs Égert & Carol S. Leonard, 2006. "The Dutch Disease in Kazakhstan: An Empirical Investigation," Focus on European Economic Integration, Oesterreichische Nationalbank (Austrian Central Bank), issue 2, pages 85-108.
    19. Lein, Sarah M. & León-Ledesma, Miguel A. & Nerlich, Carolin, 2008. "How is real convergence driving nominal convergence in the new EU Member States?," Journal of International Money and Finance, Elsevier, vol. 27(2), pages 227-248, March.
    20. Johan Mathisen, 2003. "Estimation of the Equilibrium Real Exchange Rate for Malawi," IMF Working Papers 03/104, International Monetary Fund.
    21. Maeso-Fernandez, Francisco & Osbat, Chiara & Schnatz, Bernd, 2006. "Towards the estimation of equilibrium exchange rates for transition economies: Methodological issues and a panel cointegration perspective," Journal of Comparative Economics, Elsevier, vol. 34(3), pages 499-517, September.
    22. Gianpaolo Rossini & Paolo Zanghieri, 2008. "What Drives Price Differentials of Consumables in Europe? Size? Affluence? Or Both?," Open Economies Review, Springer, vol. 19(1), pages 121-134, February.

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