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The Micro-Macro Disconnect of Purchasing Power Parity

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

This paper reconciles the persistence of aggregate real exchange rates with the faster adjustment of international relative prices in microeconomic data. Panel estimation of an error correction model using a micro data set uncovers new stylized facts regarding this puzzle. First, adjustment to purchasing power parity deviations in aggregated data is not just a slower version of adjustment to the law of one price in microeconomic data, as arbitrage occurs in different markets, in response to distinct macroeconomic and microeconomic shocks. Second, when half-lives are estimated conditional on macro shocks, micro relative prices exhibit just as much persistence as aggregate real exchange rates. These results challenge theories of real exchange rate persistence based on sticky prices and on heterogeneity across goods, and support an explanation based on the presence of distinct macro and microeconomic shocks.

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File URL: http://www.nber.org/papers/w15624.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15624.

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Date of creation: Dec 2009
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Publication status: published as Paul R. Bergin & Reuven Glick & Jyh-Lin Wu, 2013. "The Micro-Macro Disconnect of Purchasing Power Parity," The Review of Economics and Statistics, MIT Press, vol. 95(3), pages 798-812, July.
Handle: RePEc:nbr:nberwo:15624
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  1. Mario J. Crucini & Mototsugu Shintani, 2006. "Persistence in Law-of-One-Price Deviations: Evidence from Micro-data," Levine's Bibliography 321307000000000311, UCLA Department of Economics.
  2. Fisher, Eric O'N & Park, Joon Y, 1991. "Testing Purchasing Power Parity under the Null Hypothesis of Co-integration," Economic Journal, Royal Economic Society, vol. 101(409), pages 1476-84, November.
  3. Mario Crucini & Chris Telmer & Marios Zachariadis, . "Understanding European Real Exchange Rates," GSIA Working Papers 227, Carnegie Mellon University, Tepper School of Business.
  4. Mirko Wiederholt & Bartosz Mackowiak, 2005. "Optimal Sticky Prices under Rational Inattention," 2005 Meeting Papers 369, Society for Economic Dynamics.
  5. Haroon Mumtaz & Jean Imbs & Morten O. Ravn & Helene Rey, 2003. "PPP Strikes Back; Aggregation and the Real Exchange Rate," IMF Working Papers 03/68, International Monetary Fund.
  6. Pesaran, M.H., 2003. "A Simple Panel Unit Root Test in the Presence of Cross Section Dependence," Cambridge Working Papers in Economics 0346, Faculty of Economics, University of Cambridge.
  7. David C. Parsley & Shang-Jin Wei, 1996. "Convergence to the Law of One Price Without Trade Barriers or Currency Fluctuations," NBER Working Papers 5654, National Bureau of Economic Research, Inc.
  8. M. Hashem Pesaran, 2004. "Estimation and Inference in Large Heterogeneous Panels with a Multifactor Error Structure," CESifo Working Paper Series 1331, CESifo Group Munich.
  9. J�n Steinsson, 2008. "The Dynamic Behavior of the Real Exchange Rate in Sticky Price Models," American Economic Review, American Economic Association, vol. 98(1), pages 519-33, March.
  10. Yin-Wong Cheung & Kon S. Lai & Michael Bergman, 2003. "Dissecting the PPP Puzzle: The Unconventional Roles of Nominal Exchange Rate and Price Adjustment," CESifo Working Paper Series 924, CESifo Group Munich.
  11. Charles Engel & James Morley, 2000. "The Adjustment of Prices and the Adjustment of the Exchange Rate," Working Papers 0009, University of Washington, Department of Economics.
  12. Shiu-Sheng Chen & Charles Engel, 2005. "Does 'Aggregation Bias' Explain The Ppp Puzzle?," Pacific Economic Review, Wiley Blackwell, vol. 10(1), pages 49-72, 02.
  13. Christian Broda & David E. Weinstein, 2008. "Understanding International Price Differences Using Barcode Data," NBER Working Papers 14017, National Bureau of Economic Research, Inc.
  14. David Parsley Shang-Jin Wei, 2002. "Currency Arrangements And Goods Market Integration: A Price Based Approach," International Finance 0211004, EconWPA.
  15. Jyh-Lin Wu & Pei-Fen Chen & Ching-Nun Lee, 2009. "Purchasing Power Parity, Productivity Differentials And Non-Linearity," Manchester School, University of Manchester, vol. 77(3), pages 271-287, 06.
  16. Charles Engel & John H. Rogers, 2004. "European product market integration after the euro," Economic Policy, CEPR;CES;MSH, vol. 19(39), pages 347-384, 07.
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