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Persistent gaps between purchasing power parities and exchange rates under the law of one price: a puzzle (partly) explained?

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  • Leon Podkaminer

    (The Vienna Institute for International Economic Studies)

Abstract

Simple general equilibrium (exchange) models of intra-EU trade generate equalized relative prices of consumer tradables. Simultaneously, more dispersed domestic relative prices of consumer non-tradables are generated. Consequently, the purchasing power parity/exchange rate ratios may move further away from unity. The PPP/ER discrepancies may widen even when there are no impediments to free trade. While the models force the relative prices of tradables into uniformity, in reality these prices are persistently dispersed across countries. This does not vitiate the law of one price though. The retail prices of tradables depend also on prices of the local (non-tradable) inputs (e.g. distribution services). Prices of tradables net of costs of services (unobservable) may tend to obey the law of one price. The observed (retail) prices of tradables may not show this tendency even under free and competitive foreign trade because such a trade can widen the gaps between prices of non-tradables internationally.

Suggested Citation

  • Leon Podkaminer, 2013. "Persistent gaps between purchasing power parities and exchange rates under the law of one price: a puzzle (partly) explained?," Bank i Kredyt, Narodowy Bank Polski, vol. 44(4), pages 333-352.
    • Handle: RePEc:nbp:nbpbik:v:44:y:2013:i:4:p:333-352
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    References listed on IDEAS

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    1. Leon Podkaminer, 2014. "Does trade drive global output growth?," Bank i Kredyt, Narodowy Bank Polski, vol. 45(4), pages 311-330.
    2. Leon Podkaminer, 2016. "Has trade been driving global economic growth?," NBP Working Papers 251, Narodowy Bank Polski.

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    More about this item

    Keywords

    law of one price; purchasing power parities; exchange rates; general equilibrium modeling; cross-country systems of consumer demand functions;
    All these keywords.

    JEL classification:

    • F11 - International Economics - - Trade - - - Neoclassical Models of Trade
    • F15 - International Economics - - Trade - - - Economic Integration
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • O57 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies - - - Comparative Studies of Countries

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