The micro-macro disconnect of purchasing power parity

Paul Bergin, Reuven Glick and Jyh-Lin Wu

No 2010-14, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: The persistence of aggregate real exchange rates is a prominent puzzle, particularly since adjustment of international relative prices in microeconomic data is much faster. This paper finds that adjustment to the law of one price in disaggregated data is not just a faster version of the adjustment to purchasing power parity in the aggregate data; while aggregate real exchange rate adjustment works primarily through the foreign exchange market, adjustment in disaggregated data is a qualitatively distinct process, working through adjustment in local-currency goods prices. These distinct adjustment dynamics appear to arise from distinct classes of shocks generating macro and micro price deviations. A vector error correction model nesting aggregate and disaggregated relative prices permits identification of distinct macroeconomic and good-specific shocks. When half-lives are estimated conditional on shocks, the macro-micro disconnect puzzle disappears: microeconomic relative prices adjust to macro shocks just as slowly as do aggregate real exchange rates. These results provide evidence against theories of real exchange rate behavior based on sticky prices and on heterogeneity across goods.

Keywords: Foreign exchange rates; Purchasing power parity; Prices (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-cba and nep-opm
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Related works:
Journal Article: The Micro-Macro Disconnect of Purchasing Power Parity (2013)
Working Paper: The Micro-Macro Disconnect of Purchasing Power Parity (2009)
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