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The Micro-Macro Disconnect of Purchasing Power Parity

Paul R. Bergin1; Reuven Glick2; Jyh-Lin Wu3

1 University of California, Davis · 2 Federal Reserve Bank of San Francisco · 3 National Sun Yat-sen University

The Review of Economics and Statistics 2013 open access

This paper reconciles the persistence of aggregate real exchange rates with the faster adjustment of international relative prices in microeconomic data. Error correction model estimates indicate that a different mix of shocks drives international price deviations at the microeconomic level and that dynamic adjustment works through arbitrage in the goods market rather than the foreign exchange market. When half-lives are estimated conditional on a common set of estimated macro shocks, we find that micro relative prices exhibit every bit as much persistence as aggregate real exchange rates. These results challenge theories of real exchange rate persistence based on sticky prices and heterogeneity across goods.

DOI
10.1162/rest_a_00335
Volume
95 (3)
Pages
798-812
Language
en
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