Dissecting the PPP puzzle: the unconventional roles of nominal exchange rate and price adjustments

YW Cheung, KS Lai, Michael Bergman

Research output: Contribution to journalArticlepeer-review

Abstract

The conventional view, as expounded by sticky-price models, is that price adjustment determines the PPP reversion rate. This study examines the mechanism by which PPP deviations are corrected. Nominal exchange rate adjustment, not price adjustment, is shown to be the key engine governing the speed of PPP convergence. Moreover, nominal exchange rates are found to converge much more slowly than prices. With the reversion being driven primarily by nominal exchange rates, real exchange rates also revert at a slower rate than prices, as identified by the PPP puzzle [J. Econ. Lit. 34 (1996) 647]. (C) 2003 Elsevier B.V. All rights reserved.
Original languageEnglish
Pages (from-to)135-150
JournalJournal of International Economics
Volume64
Issue number1
DOIs
Publication statusPublished - 2004

Subject classification (UKÄ)

  • Economics

Free keywords

  • purchasing power parity
  • half-life
  • impulse responses
  • generalized
  • price adjustment speed

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