Purchasing Power Parity and New Trade Theory

Luca Ricci and Ronald MacDonald

No 2002/032, IMF Working Papers from International Monetary Fund

Abstract: This paper theoretically derives and empirically tests the implications of a new trade theory framework for the systematic movements in the real exchange rate. It focuses on the effect of imperfect substitutability of tradables and on the importance of competitiveness, for which we construct an original proxy. Using a panel dynamic OLS estimation of nine bilateral US dollar real exchange rates, we derive long-run coefficients for relative productivity and competitiveness in the tradable and non-tradable sectors, controlling for standard macroeconomic variables. The implications of imperfect substitutability of tradables fit the data better than the standard neoclassical assumption of price equalization. Our new measure of competitiveness is statistically significant in explaining deviations from PPP.

Keywords: WP; New trade theory; real exchange rates; purchasing power parity; productivity differentials; the PPP puzzle; productivity term; productivity of tradables; competitiveness term; coefficient restriction; productivity of non-tradables; utility function; productivity in tradables; Productivity; Competition; Wages; Real interest rates (search for similar items in EconPapers)
Pages: 35
Date: 2002-02-01
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Citations: View citations in EconPapers (47)

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