Modeling Deviations from Purchasing Power Parity (PPP)

Joshua Aizenman

25 citations0/0 files storedNational Bureau of Economic Research

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Monetary Policy and Economic Impact Global Financial Crisis and Policies Economic theories and models

Abstract

The volatility of the exchange rate under floating rates can be interpreted in terms of approaches that allow for short term price rigidity as well as in terms of models that consider the magnification effect of new information.This paper combines the two approaches into a unified framework, where the degree to which prices are rigid is determined endogenously.It is shown that the variance of percentage deviations from ppp has an upper bound, and that the relationship between the variance of deviations from ppp and the aggregate variability is not inonotonic.Allowing for a short-run Phillips curve with optimal indexation, it is also demonstrated that a higher price flexibility will reduce deviations from ppp and output volatility.

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References

1976Expectations and Exchange Rate Dynamics 1977A Monetary Approach To The Exchange Rate: Doctrinal Aspects And Empirical Evidence 1976Wage indexation: A macroeconomic approach 1976How Far Can We Push The "Law of One Price"?1982The Transmission of Disturbances under Alternative Exchange-Rate Regimes with Optimal Indexing 1976A Note on the Relation between the Rate and Variability of Inflation 1976Wage-indexation and macro-economic stability 1977Price-Level Stickiness and the Feasibility of Monetary Stabilization Policy with Rational Expectations

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1986Testing deviations from purchasing power parity 1982The Exchange-Rate Effects of Real Disturbances with Rational Expectations and Variable Terms of Trade 1987Real exchange rate variability and monetary disturbances 1986Empirical determinants of purchasing power parity deviations 1996Real exchange rates and the pattern of trade: comparative dynamics for north and south

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