Purchasing Power Disparity During the Floating Rate Period: Exchange Rate Volatility, Trade Barriers and Other Culprits

Shang‐Jin Wei · David C. Parsley

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Monetary Policy and Economic Impact Global trade and economics Global Financial Crisis and Policies

Abstract

Using a panel of 12 tradable sectors in 91 OECD country pairs (14 countries), we study the deviations from the purchasing power parity during the recent floating exchange rate period. (1) We find some evidence that the deviations are positively related to exchange rate volatility as well as to transportation costs. (2) Once we have controlled for these two factors, free trade areas such as the EC and the EFTA do not seem to reduce significantly the deviations from PPP relative to other OECD countries. (3) Although only using the post- 1973 data, we are able to find strong evidence of mean reversion towards PPP. The estimated half lives of the deviation from PPP are about four years and three quarters for the non-EMS countries in the sample, and four years and one quarter for the EMS countries. (4) We find evidence of non-linearity in the rate of mean reversion: the convergence occurs faster for country pairs with larger initial deviations.

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2001The Choice of Numeraire Currency in Panel Tests of Purchasing Power Parity 1998Real exchange rates under the recent float: unequivocal evidence of mean reversion 1997The Behaviour of Real Exchange Rates During the Post-Bretton Woods Period 2000On cross-country differences in the persistence of real exchange rates 2002“The bigger they are, the harder they fall”: Retail price differences across U.S. cities 1996Relative Labor Productivity and the Real Exchange Rate in the Long Run: Evidence for a Panel of OECD Countries 1995A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries 1998Increasing evidence of purchasing power parity over the current float

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