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“Conditional PPP” and Real Exchange Rate Convergence in the Euro Area

Paul Bergin, Reuven Glick () and Jyh-Lin Wu
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Jyh-Lin Wu: National Sun Yat-Sen University,

No 2016-29, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: While economic theory highlights the usefulness of flexible exchange rates in promoting adjustment in international relative prices, flexible exchange rates also can be a source of destabilizing shocks. We find that when countries joining the euro currency union abandoned their national exchange rates, the adjustment of real exchange rates toward their long-run equilibrium surprisingly became faster. To investigate, we distinguish between differing rates of purchasing power parity (PPP) convergence conditional on alternative shocks, which we refer to as “conditional PPP.” We find that the loss of the exchange rate as an adjustment mechanism after the introduction of the euro was more than compensated by the elimination of the exchange rate as a source of shocks, in combination with faster adjustment in national prices. These findings support claims that flexible exchange rates are not necessary to promote long-run international relative price adjustment.

JEL-codes: F00 F15 F31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-eec and nep-opm
Date: 2016-10-18
Note: This draft: October 18, 2016
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Journal Article: “Conditional PPP” and real exchange rate convergence in the euro area (2017) Downloads
Working Paper: Conditional PPP and Real Exchange Rate Convergence in the Euro Area (2016) Downloads
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DOI: 10.24148/wp2016-29

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Handle: RePEc:fip:fedfwp:2016-29