The ‘Real’ Explanation of the PPP Puzzle

7 Pages Posted: 25 Apr 2016

See all articles by Nicholas Ford

Nicholas Ford

University of Cambridge - Wolfson College

Charles Yuji Horioka

Asian Growth Research Institute; National Bureau of Economic Research (NBER); Osaka University - Institute of Social and Economic Research (ISER)

Date Written: April 21, 2016

Abstract

This article shows that global financial markets cannot, by themselves, achieve net transfers of financial capital and real interest rate equalisation across countries and that the integration of both global financial markets and global goods markets is needed to achieve net transfers of capital and real interest rate equalisation across countries. Thus, frictions (barriers to mobility) in one or both of these markets can impede the net transfer of capital between countries, produce the Feldstein and Horioka (1980) finding of high saving-investment correlations, and prevent real interest rates from being equalised across countries. Moreover, frictions in global goods markets can explain why real exchange rates deviate from PPP (purchasing power parity) for extended periods of time and can therefore also explain the PPP puzzle. Thus, we are able to resolve 2 of Obstfeld and Rogoff’s (2000) “6 major puzzles in macroeconomics” with essentially the same explanation.

Keywords: Feldstein-Horioka paradox or puzzle, financial and goods market integration, net transfers of capital, PPP or purchasing power parity puzzle, real interest rate equalisation or parity, saving-investment correlations

JEL Classification: E40, F21, F31, F32, F36, G15

Suggested Citation

Ford, Nicholas and Horioka, Charles Yuji, The ‘Real’ Explanation of the PPP Puzzle (April 21, 2016). ISER Discussion Paper No. 969. Available at SSRN: https://ssrn.com/abstract=2768528 or http://dx.doi.org/10.2139/ssrn.2768528

Nicholas Ford

University of Cambridge - Wolfson College ( email )

Barton Road
Cambridge, CB3 9BB
United Kingdom

Charles Yuji Horioka (Contact Author)

Asian Growth Research Institute ( email )

11-4, Ohtemachi, Kokurakita-ku
Kitakyushu, Fukuoka 803-0814
Japan

HOME PAGE: http://www.agi.or.jp

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Osaka University - Institute of Social and Economic Research (ISER) ( email )

6-1 Mihogaoka
Ibaraki, Osaka 567-0047
Japan

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