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Is there PPP in the data? New evidence from a structural DSGE model

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Abstract

There has been a long-running debate in international macroeconomics about whether there is purchasing power parity (PPP) in the data. While the literature has been dominated by reduced-form evidence focusing on real exchange rate dynamics, little attention has been paid to establishing whether a full structural model with PPP can empirically explain the data. This paper tests a DSGE model in which long-run trade forces drive the exchange rate back to PPP, while short-run shocks cause deviations. Using UK and US data from 1997 to 2020, the model is tested via Indirect Inference and fits the data well, suggesting that trade-driven forces consistently push the real exchange rate back to a PPP equilibrium despite short-term shocks and policy pressures.

Suggested Citation

  • Minford, Patrick & Ou, Zhirong & Zhu, Zheyi, 2025. "Is there PPP in the data? New evidence from a structural DSGE model," Cardiff Economics Working Papers E2025/6, Cardiff University, Cardiff Business School, Economics Section.
    • Handle: RePEc:cdf:wpaper:2025/6
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    Keywords

    PPP; real exchange rate behaviour; two-country DSGE model; indirect inference test;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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