Is there PPP in the data? New evidence from a structural DSGE model

A. Patrick Minford, Zhirong Ou and Zheyi Zhu
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Zheyi Zhu: Cardiff Business School

No E2025/6, Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section

Abstract: There has been a long-running debate in international macroeconomics about whether there is purchasing power parity (PPP) in the data. While the literature has been dominated by reduced-form evidence focusing on real exchange rate dynamics, little attention has been paid to establishing whether a full structural model with PPP can empirically explain the data. This paper tests a DSGE model in which long-run trade forces drive the exchange rate back to PPP, while short-run shocks cause deviations. Using UK and US data from 1997 to 2020, the model is tested via Indirect Inference and fits the data well, suggesting that trade-driven forces consistently push the real exchange rate back to a PPP equilibrium despite short-term shocks and policy pressures.

Keywords: PPP; real exchange rate behaviour; two-country DSGE model; indirect inference test (search for similar items in EconPapers)
JEL-codes: E32 F31 F41 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2025-03
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