PPP Strikes Back: Aggregation and the Real Exchange Rate

Haroon Mumtaz, Jean Imbs, Morten Ravn and Helene Rey

No 2003/068, IMF Working Papers from International Monetary Fund

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.

Keywords: WP; exchange rate; Real exchange rate persistence; purchasing power parity; aggregation; parameter heterogeneity; mean reversion; OLS estimator; reversion increase; goods price; traded goods; OLS estimate; time series; estimation procedure; panel estimation; least squares; Arellano-Bond estimator; half-life estimate; Real exchange rates; Exchange rates; Estimation techniques; Price indexes; Europe (search for similar items in EconPapers)
Pages: 42
Date: 2003-04-01
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Citations: View citations in EconPapers (41)

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Related works:
Journal Article: PPP Strikes Back: Aggregation And the Real Exchange Rate (2005)
Working Paper: PPP Strikes Back: Aggregation and the Real Exchange Rate (2005)
Working Paper: PPP Strikes Back: Aggregation and the Real Exchange Rate (2003)
Working Paper: PPP Strikes Back: Aggregation and the Real Exchange Rate (2003)
Working Paper: PPP Strikes Back: Aggregation and the Real Exchange Rate (2002)
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