Aggregation and the PPP Puzzle in a Sticky-Price Model

Carlos Carvalho and Fernanda Nechio

American Economic Review, 2011, vol. 101, issue 6, 2391-2424

Abstract: We study the purchasing power parity (PPP) puzzle in a multisector, two-country, sticky-price model. Sectors differ in the extent of price stickiness, leading to heterogeneous sectoral real exchange rate dynamics. Deviations from PPP are more volatile and persistent than in an otherwise identical one-sector world economy with the same average frequency of price changes. Under the empirical distribution of price stickiness of the US economy, the model produces PPP deviations with a half-life of 39 months. We provide a structural interpretation of the approaches found in the empirical literature on aggregation and PPP, and reconcile its apparently conflicting findings. (JEL F31, G31)

Date: 2011
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Working Paper: Aggregation and the PPP puzzle in a sticky-price model (2010)
Working Paper: Aggregation and the PPP puzzle in a sticky-price model (2008)
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