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Purchasing power parity, wages and inflation in emerging markets

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  • Goyal, Ashima

    () (Indira Gandhi Institute of Development Research)

Abstract

Persistent deviation of real exchange rates from purchasing power parity (PPP) values is a puzzle, since nominal shocks, which cause such deviation, are expected to have only short-run effects. If some goods are non-traded, Balassa Samuelson (BS) showed how such deviations occur and explain why the price level is relatively higher in advanced economies. But then, consistently higher inflation in emerging or developing economies (EDE) is another puzzle. The paper presents a framework giving a new simple proof of the BS result. If the assumption that the price level is fixed for the EDE is dropped, nominal depreciation interacting with different types of wage rigidities can explain higher inflation, as nominal wages rise in response to a nominal depreciation. Then monetary shocks have persistent effects but these shocks can arise from large capital flows independent of changes in domestic money supply. Evidence from India supports the hypotheses.

Suggested Citation

  • Goyal, Ashima, 2012. "Purchasing power parity, wages and inflation in emerging markets," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2012-025, Indira Gandhi Institute of Development Research, Mumbai, India.
  • Handle: RePEc:ind:igiwpp:2012-025
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    References listed on IDEAS

    as
    1. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
    2. Ashima Goyal, 2010. "Inflationary pressures in South Asia," Asia-Pacific Development Journal, United Nations Economic and Social Commission for Asia and the Pacific (ESCAP), vol. 17(2), pages 1-42, December.
    3. Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, vol. 72, pages 584-584.
    4. Robert Summers & Alan Heston, 1991. "The Penn World Table (Mark 5): An Expanded Set of International Comparisons, 1950–1988," The Quarterly Journal of Economics, Oxford University Press, vol. 106(2), pages 327-368.
    5. Bhagwati, Jagdish N, 1984. "Why Are Services Cheaper in the Poor Countries?," Economic Journal, Royal Economic Society, vol. 94(374), pages 279-286, June.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Purchasing power parity; inflation differentials; wage rigidities;

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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