PPP Strikes Back: Aggregation and the Real Exchange Rate

42 Pages Posted: 28 Jan 2006

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: April 2003

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

Imbs, Jean M. and Mumtaz, Haroon and Ravn, Morten O. and Rey, Helene, PPP Strikes Back: Aggregation and the Real Exchange Rate (April 2003). IMF Working Paper, Vol. , pp. 1-42, 2003. Available at SSRN: https://ssrn.com/abstract=879143

Jean M. Imbs (Contact Author)

Paris School of Economics (PSE) ( email )

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Centre for Economic Policy Research (CEPR)

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Swiss Finance Institute ( email )

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Haroon Mumtaz

University of London - School of Sciences ( email )

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Morten O. Ravn

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

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Helene Rey

London Business School ( 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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