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PPP Strikes Back: Aggregation and the Real Exchange Rate

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Author Info
Imbs, Jean
Mumtaz, Haroon
Ravn, Morten O.
Rey, Hélène

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Abstract

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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3715.

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Date of creation: Jan 2003
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Handle: RePEc:cpr:ceprdp:3715

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Related research
Keywords: aggregation; parameter heterogeneity; purchasing power parity; real exchange rate persistence;

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Find related papers by JEL classification:
C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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