A Resolution of the Purchasing Power Parity Puzzle: Imperfect Knowledge and Long Swings

39 Pages Posted: 15 Dec 2008

See all articles by Roman Frydman

Roman Frydman

New York University (NYU) - Department of Economics

Michael D. Goldberg

University of New Hampshire

Soren Johansen

University of Copenhagen - Department of Economics; Aarhus University - CREATES

Katarina Juselius

University of Copenhagen - Department of Economics

Date Written: December 8, 2008

Abstract

Asset prices undergo long swings that revolve around benchmark levels. In currency markets, fluctuations involve real exchange rates that are highly persistent and that move in near-parallel fashion with nominal rates. The inability to explain these two regularities with one model has been called the "Purchasing Power Parity puzzle". In this paper, we trace the puzzle to exchange rate modelers' use of the "Rational Expectations Hypothesis". We show that once imperfect knowledge is recognized, a monetary model is able to account for the puzzle, as well as other salient features of the data, including the long-swings behavior of exchange rates.

Keywords: PPP puzzle, Long Swings, Imperfect Knowledge, Rational Expectations

JEL Classification: F31, F41, G15, G17

Suggested Citation

Frydman, Roman and Goldberg, Michael D. and Johansen, Soren and Juselius, Katarina, A Resolution of the Purchasing Power Parity Puzzle: Imperfect Knowledge and Long Swings (December 8, 2008). Univ. of Copenhagen Dept. of Economics Discussion Paper No. 08-31. Available at SSRN: https://ssrn.com/abstract=1315233 or http://dx.doi.org/10.2139/ssrn.1315233

Roman Frydman

New York University (NYU) - Department of Economics ( email )

19 West 4th Street
New York, NY 10012
United States

Michael D. Goldberg

University of New Hampshire ( email )

Durham, NH 03824
United States
603-862-3385 (Phone)
603-862-3383 (Fax)

HOME PAGE: http://pubpages.unh.edu/~michaelg/

Soren Johansen

University of Copenhagen - Department of Economics ( email )

Øster Farimagsgade 5
Bygning 26
1353 Copenhagen K.
Denmark

Aarhus University - CREATES ( email )

Nordre Ringgade 1
Aarhus, DK-8000
Denmark

Katarina Juselius (Contact Author)

University of Copenhagen - Department of Economics ( email )

Øster Farimagsgade 5
Bygning 26
1353 Copenhagen K.
Denmark

Register to save articles to
your library

Register

Paper statistics

Downloads
55
Abstract Views
581
rank
187,787
PlumX Metrics