PPP Strikes Back: Aggregation and the Real Exchange Rate

Imbs, Jean M.; Mumtaz, Haroon; Ravn, Morten O.; Rey, Hélène

doi:10.2139/ssrn.354780

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PPP Strikes Back: Aggregation and the Real Exchange Rate

55 Pages Posted: 13 Mar 2003

See all articles by Jean M. Imbs

Jean M. Imbs

Paris School of Economics (PSE); NYU Abu Dhabi; Centre for Economic Policy Research (CEPR)

Haroon Mumtaz

Bank of England; University of London - School of Sciences

European University Institute - Economics Department (ECO); London Business School - Department of Economics; University of Southampton; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Hélène Rey

London Business School; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

There are 5 versions of this paper

Date Written: December 2002

Abstract

We show the importance of a dynamic aggregation bias in accounting for the PPP puzzle. We prove that established time series and panel methods substantially exaggerate the persistence of real exchange rates because of heterogeneity in the dynamics of disaggregated relative prices. When heterogeneity is properly taken into account, estimates of the real exchange rate half-life fall dramatically, to little more than one year, or significantly below Rogoff's "consensus view" of three to five years. We show that corrected estimates are consistent with plausible nominal rigidities, thus, arguably, solving the PPP puzzle.

Keywords: Real Exchange Rate Persistence, Purchasing Power Parity, Aggregation, Parameter Heterogeneity

JEL Classification: F36, F41, C43

Suggested Citation: Suggested Citation

Imbs, Jean M. and Imbs, Jean M. and Mumtaz, Haroon and Mumtaz, Haroon and Ravn, Morten O. and Rey, Helene, PPP Strikes Back: Aggregation and the Real Exchange Rate (December 2002). Available at SSRN: https://ssrn.com/abstract=354780 or http://dx.doi.org/10.2139/ssrn.354780