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PPP Strikes Back: Aggregation and the Real Exchange Rate

Author

Listed:
  • Jean Imbs

    (Centre for Economic Policy Research)

  • Haroon Mumtaz

    (London Business School)

  • Morten O. Ravn

    (Centre for Economic Policy Research)

  • Helene Rey

    (Centre for Economic Policy Research)

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.

Suggested Citation

  • Jean Imbs & Haroon Mumtaz & Morten O. Ravn & Helene Rey, 2003. "PPP Strikes Back: Aggregation and the Real Exchange Rate," CERS-IE WORKING PAPERS 0307, Institute of Economics, Centre for Economic and Regional Studies.
    • Handle: RePEc:has:discpr:0307
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    More about this item

    Keywords

    Real Exchange Rate Persistence; Purchasing Power Parity; Aggregation; Parameter Heterogeneity.;
    All these keywords.

    JEL classification:

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

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