VECM Estimations of the PPP Reversion Rate Revisited: The Conventional Role of Relative Price Adjustment Restored

Hyeongwoo Kim ()

No auwp2010-03, Auburn Economics Working Paper Series from Department of Economics, Auburn University

Abstract: Cheung et al. (2004) use a vector error correction model that allows different speeds of convergence for nominal exchange rates and relative prices toward PPP. With the current float monthly data for five countries, they argue that the sluggish PPP reversion is primarily driven by nominal exchange rate adjustment rather than price adjustment, which is at odds with the conventional sticky-price models. Major findings of this paper are twofold. First, we show that it may be inappropriate to use short-horizon high frequency data in vector error correction models, even when both the nominal exchange rate and the relative price are not weakly exogenous. Second, using a long-horizon annual data set for 11 countries vis-?vis the US, we find a significantly important role of relative prices in real exchange rate dynamics.

Keywords: Purchasing Power Parity; Convergence Rate; Half-Life; Impulse-Response; Variance Decomposition (search for similar items in EconPapers)
JEL-codes: C32 F31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba and nep-opm
Date: 2010-05
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Related works:
Journal Article: VECM estimations of the PPP reversion rate revisited: The conventional role of relative price adjustment restored (2012)
Working Paper: VECM estimations of the PPP reversion rate revisited: the conventional role of relative price adjustment restored (2011)
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