Violating Purchasing Power Parity

FRB of Philadelphia Working Paper No. 04-19

45 Pages Posted: 28 Oct 2004

See all articles by George Alessandria

George Alessandria

Federal Reserve Bank of Philadelphia

Joseph P. Kaboski

Ohio State University (OSU) - Economics; National Bureau of Economic Research (NBER); University of Notre Dame - Department of Economics

Date Written: September 2004

Abstract

This paper demonstrates that deviations from the law of one price are an important source of violations of absolute PPP across countries. Using highly disaggregated U.S. export data, we document evidence of systematic international price discrimination based on the local wage of consumers in the destination market. We show that most violations from absolute PPP can also be explained by international differences in wages. We find very little additional explanation is due to differences in income per capita. Developing and calibrating a model of pricing-to-market based on search frictions and international productivity differences, we show that pricing-to-market accounts for 62 percent of the relationship between national price levels and income and 100 percent of the deviation from the law of one price. In contrast, the textbook Harrod-Balassa-Samuelson effect accounts for the remaining 38 percent of the relationship between national price levels and income.

Keywords: PPP, Pricing-To-Market, Law of One Price

JEL Classification: E31, F12

Suggested Citation

Alessandria, George A. and Kaboski, Joseph P., Violating Purchasing Power Parity (September 2004). FRB of Philadelphia Working Paper No. 04-19. Available at SSRN: https://ssrn.com/abstract=606661 or http://dx.doi.org/10.2139/ssrn.606661

George A. Alessandria (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

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Philadelphia, PA 19106-1574
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(215) 574-4364 (Fax)

Joseph P. Kaboski

Ohio State University (OSU) - Economics ( email )

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United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
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University of Notre Dame - Department of Economics ( email )

Notre Dame, IN 46556
United States

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