Co-movements in international dollar price levels

This paper studies the relation between movements in the U.S. price level and the dollar price levels of nineteen other countries. Using the band pass filter developed by Christiano and Fitzgerald (2003), we examine correlations between dollar prices when decomposed into their high, medium, and low frequency cycles. The low frequency cycle in the U.S. price series is highly correlated with low frequency cycles in dollar price levels of the majority of countries in our sample. The high correlation between low frequency cycles persists over a variety of historical sub-periods, including the eras of fixed and flexible nominal exchange rates. This result, suggesting the existence of a common long-run price cycle, is consistent with long-run purchasing power parity. In contrast, both high and medium frequency cycles are more highly correlated prior to the Great Depression. This result is consistent with studies finding greater stability of real exchange rates during the era of the gold standard. Also, it appears that the increased volatility of U.S. real exchange rates after the 1973 move to flexible exchange rates was largely due to declines in the co-movement of short-run dollar price cycles.