Purchasing Power Disparity During the Floating Rate Period: Exchange Rate Volatility, Trade Barriers and Other Culprits, Issue 5032
National Bureau of Economic Research, 1995 - Foreign exchange - 31 pages
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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12 Tradable Sectors 91 country pairs annual decay rate cointegration convergence towards PPP costs and exchange country pair dummies cross-country price differentials deviations from PPP different from zero Dummies yes yes Economic EFTA countries Engel and Rogers Error of Regression European Monetary System evidence of mean exchange rate variability exchange rate volatility factors faster rate floating exchange rate Frankel free trade areas Froot and Rogoff initial price differential instrumental variable j's currency long time series Mac prices mean reversion monthly exchange rates NBER Working Papers non-EMS countries Non-Tradable Sectors null hypothesis Number of Observations OECD Data percent price stickiness purchasing power parity rate of convergence Regression 3 Regression regression results reject the null reversion towards PPP sample Sector Dummies yes sector-specific shipping costs slope parameters specification standard deviation Standard errors statistically significant subsample transportation costs units of i's variability of price yes Adjusted R-squared yes yes Country yes yes yes