PPP Strikes Back: Aggregation and the Real Exchange Rate

42 Pages Posted: 19 Dec 2002 Last revised: 30 Oct 2010

See all articles by Jean M. Imbs

Jean M. Imbs

Paris School of Economics (PSE); Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Haroon Mumtaz

University of London - School of Sciences

Morten O. Ravn

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)

Multiple version iconThere 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 corrected estimates are consistent with plausible nominal rigidities, thus, arguably, solving the puzzle. We also explain why traded goods prices account for the bulk of the persistence and volatility of the real exchange rate. The reason is that traded goods prices display dynamics that are more heterogeneous than non-traded ones.

Suggested Citation

Imbs, Jean M. and Mumtaz, Haroon and Ravn, Morten O. and Rey, Helene, PPP Strikes Back: Aggregation and the Real Exchange Rate (December 2002). NBER Working Paper No. w9372. Available at SSRN: https://ssrn.com/abstract=359309

Jean M. Imbs

Paris School of Economics (PSE) ( email )

48 Boulevard Jourdan
Paris, 75014 75014
France

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute ( email )

c/o University of Geneve
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Switzerland

Haroon Mumtaz

University of London - School of Sciences ( email )

London, WC1E 7HX
United Kingdom

Morten O. Ravn

European University Institute - Economics Department (ECO) ( email )

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Italy

London Business School - Department of Economics ( email )

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University of Southampton ( email )

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Centre for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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Helene Rey (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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