Can Non-Linear Real Shocks Explain The Persistence of PPP Exchange Rate Disequilibria?

Tuomas Antero Peltonen (), Adina Popescu () and Michael Sager ()
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Adina Popescu: European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany., http://www.ecb.europa.eu/home/html/index.en.html

No 1073, Working Paper Series from European Central Bank

Abstract: A core stylized fact of the empirical exchange rate literature is that half-life deviations of equilibrium real exchange rates from levels implied by Purchasing Power Parity (PPP) are very persistent. Empirical efforts to explain this persistence typically proceed along two distinct paths, resorting either to the presence of real shocks such as productivity differentials that drive equilibrium exchange rates away from levels implied by PPP, or the presence of non-linearities in the adjustment process around PPP. By contrast, we combine these two explanations in the context of an innovative panel estimation methodology. We conclude that both explanations are relevant to the behavior of exchange rates and that resulting half-lives are much shorter than estimated using linear PPP and more consistent with the observed volatility of nominal and real exchange rates. JEL Classification: F31, C23, L6-L9.

Keywords: EPSTAR; exchange rate; PPP; Balassa-Samuelson; productivity. (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ifn and nep-opm
Date: 2009-07
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