PPP Strikes Back: Aggregation and the Real Exchange Rate

Author/Editor:

Haroon Mumtaz ; Jean Imbs ; Morten O. Ravn ; Helene Rey

Publication Date:

April 1, 2003

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

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.

Series:

Working Paper No. 2003/068

Subject:

Econometric analysis Estimation techniques Exchange rates Foreign exchange Price indexes Prices Purchasing power parity Real exchange rates

English

Publication Date:

April 1, 2003

ISBN/ISSN:

9781451849011/1018-5941

Stock No:

WPIEA0682003

Pages:

42

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