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VECM estimations of the PPP reversion rate revisited: the conventional role of relative price adjustment restored

Listed author(s):
  • Kim, Hyeongwoo

Cheung et al. (2004) use a vector error correction model (VECM) for the current float nominal exchange rate and the relative price data and claim that the sluggish Purchasing Power Parity (PPP) reversion is primarily driven by the nominal exchange rate, not by relative price adjustment, which is at odds with the conventional sticky-price models. Our major findings are as follows. First, we suggest cases where VECMs are of limited usefulness even when all the variables in the system are not weakly exogenous. Second, using century-long exchange rates, we find that the relative price plays an important role for PPP reversion when real shocks occur. Third, protracted hump-shaped responses of real exchange rates are frequently observed when there is a relative price shock, leading to sluggish adjustments toward PPP. Nominal exchange rate shocks generate humped dynamics much less frequently.

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File URL: https://mpra.ub.uni-muenchen.de/33005/1/MPRA_paper_33005.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 33005.

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Date of creation: Aug 2011
Handle: RePEc:pra:mprapa:33005
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  5. Hyeongwoo Kim, 2013. "Generalized impulse response analysis: General or Extreme?," EconoQuantum, Revista de Economia y Negocios, Universidad de Guadalajara, Centro Universitario de Ciencias Economico Administrativas, Departamento de Metodos Cuantitativos y Maestria en Economia., vol. 10(2), pages 135-141, Julio - D.
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