Purchasing Power Parity and New Trade Theory

35 Pages Posted: 29 Jan 2006

See all articles by Ronald MacDonald

Ronald MacDonald

University of Strathclyde in Glasgow - Department of Economics; Government of New Zealand - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Luca A. Ricci

International Monetary Fund (IMF) - Research Department

Date Written: February 2002

Abstract

This paper theoretically derives and empirically tests the implications of a new trade theory framework for the systematic movements in the real exchange rate. It focuses on the effect of imperfect substitutability of tradables and on the importance of competitiveness, for which we construct an original proxy. Using a panel dynamic OLS estimation of nine bilateral US dollar real exchange rates, we derive long-run coefficients for relative productivity and competitiveness in the tradable and non-tradable sectors, controlling for standard macroeconomic variables. The implications of imperfect substitutability of tradables fit the data better than the standard neoclassical assumption of price equalization. Our new measure of competitiveness is statistically significant in explaining deviations from PPP.

Keywords: New trade theory, real exchange rates, purchasing power parity, productivity differentials, the PPP puzzle

JEL Classification: F31

Suggested Citation

MacDonald, Ronald R. and Ricci, Luca Antonio, Purchasing Power Parity and New Trade Theory (February 2002). IMF Working Paper No. 02/32, Available at SSRN: https://ssrn.com/abstract=879396

Ronald R. MacDonald (Contact Author)

University of Strathclyde in Glasgow - Department of Economics ( email )

100 Cathedral Street
Glasgow G4 0LN
United Kingdom
+44 141 548 3861 (Phone)

Government of New Zealand - Department of Economics

2 The Terrace
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New Zealand

CESifo (Center for Economic Studies and Ifo Institute)

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Germany

HOME PAGE: http://www.CESifo.de

Luca Antonio Ricci

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-6007 (Phone)
202-623-4072 (Fax)

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