Why PPP Real Exchange Rates Mislead

Larry Sjaastad

Journal of Applied Economics, 1998, vol. 1, issue 1, 179-207

Abstract: This paper investigates the properties of the purchasing-power-parity (PPP) real exchange rate as a proxy for the true real exchange rate, which is defined as the relative price of traded goods. It finds that the PPP real exchange rate is prone to measurement error and examines the nature of that error. Measurement error is defined as the fraction of the variance of the PPP real exchange rate that has no counterpart in the true real exchange rate. That measurement error is estimated for seven small countries and the results indicate that, in most cases, the error component of PPP real exchange rates is extremely high.

Date: 1998
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DOI: 10.1080/15140326.1998.12040522

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