Mussa Redux and Conditional PPP

38 Pages Posted: 25 Aug 2012 Last revised: 28 Aug 2012

See all articles by Paul R. Bergin

Paul R. Bergin

University of California, Davis - Department of Economics; National Bureau of Economic Research (NBER)

Reuven Glick

Federal Reserve Bank of San Francisco - Center for Pacific Basin Monetary & Economic Studies

Jyh-Lin Wu

National Sun Yat-sen University; National Chung Cheng University - Department of Economics

Date Written: August 2012

Abstract

Long half-lives of real exchange rates are often used as evidence against monetary sticky price models. In this study we show how exchange rate regimes alter the long-run dynamics and half-life of the real exchange rate, and we recast the classic defense of such models by Mussa (1986) from an argument based on short-run volatility to one based on long-run dynamics. The first key result is that the extremely persistent real exchange rate found commonly in post Bretton Woods data does not apply to the preceding fixed exchange rate period in our sample, where the half-live was perhaps half as large. This result suggests a reinterpretation of Mussa's original finding, indicating that up to two thirds of the rise in variance of the real exchange rate in the recent period is actually due to the rise in persistence of the response to shocks, rather than due to a rise in the variance of shocks themselves. The second key result explains the rise in persistence over time by identifying underlying shocks using a panel VECM model. Shocks to the nominal exchange rate induce more persistent real exchange rate responses compared to price shocks, and these shocks became more prevalent under a flexible exchange rate regime.

Suggested Citation

Bergin, Paul R. and Glick, Reuven and Wu, Jyh-Lin, Mussa Redux and Conditional PPP (August 2012). NBER Working Paper No. w18331. Available at SSRN: https://ssrn.com/abstract=2136001

Paul R. Bergin (Contact Author)

University of California, Davis - Department of Economics ( email )

One Shields Drive
1141 Social Sciences & Humanities Bldg.
Davis, CA 95616-8578
United States
530-752-8398 (Phone)
530-752-9382 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Reuven Glick

Federal Reserve Bank of San Francisco - Center for Pacific Basin Monetary & Economic Studies ( email )

101 Market Street
San Francisco, CA 94105
United States
415-974-3184 (Phone)
415-974-2168 (Fax)

Jyh-Lin Wu

National Sun Yat-sen University ( email )

70 Lien-hai Rd.
Kaohsiung 80424, 80743
Taiwan

National Chung Cheng University - Department of Economics

168 Univeristy Road
Ming-Hsiung, Chia-Yi, Taiwan 621
Taiwan

Register to save articles to
your library

Register

Paper statistics

Downloads
4
Abstract Views
268
PlumX Metrics