Price equalization does not imply free trade
In this paper we show that price equalization alone is not sufficient to establish that there are no barriers to international trade. There are many barrier combinations that deliver price equalization, but each combination implies a different volume of trade. Therefore, in order to make statements about trade barriers it is necessary to know the trade flows. We demonstrate this first in a simple two-country model. We then extend the result to a multi-country model with two sectors. We show that for the case of capital goods trade, barriers have to be large in order to be consistent with the ...
Burgernomics: a big MacT guide to purchasing power parity
The theory of purchasing power parity (PPP) has long been a staple of international economic analysis. Recent years have seen the rise in popularity of a tongue-in-cheek, fast-food version of PPP: The Big Mac? index. In this article, Michael Pakko and Patricia Pollard describe how comparisons of Big Mac prices around the world contain the ingredients necessary to demonstrate the fundamental principles of PPP. They show that the Big Mac index does nearly as well as more comprehensive measures of international price comparisons and that deviations from ?McParity? illustrate why PPP often ...
Burger survey provides taste of international economics
An annual survey on the price of a hamburger in countries around the globe provides a surprisingly meaty lesson about relative currency valuations.
Purchasing power parity as a monetary standard
The micro-macro disconnect of purchasing power parity
The persistence of aggregate real exchange rates is a prominent puzzle, particularly since adjustment of international relative prices in microeconomic data is much faster. This paper finds that adjustment to the law of one price in disaggregated data is not just a faster version of the adjustment to purchasing power parity in the aggregate data; while aggregate real exchange rate adjustment works primarily through the foreign exchange market, adjustment in disaggregated data is a qualitatively distinct process, working through adjustment in local-currency goods prices. These distinct ...
Aggregation and the PPP puzzle in a sticky-price model
We study the purchasing power parity (PPP) puzzle in a multi-sector, two-country, sticky- price model. Across sectors, firms differ in the extent of price stickiness, in accordance with recent microeconomic evidence on price setting in various countries. Combined with local currency pricing, this leads sectoral real exchange rates to have heterogeneous dynamics. We show analytically that in this economy, deviations of the real exchange rate from PPP are more volatile and persistent than in a counterfactual one-sector world economy that features the same average frequency of price changes, and ...
PPP rules, macroeconomic (In)stability and learning
Governments in emerging economies have pursued real exchange rate targeting through Purchasing Power Parity (PPP) rules that link the nominal depreciation rate to either the deviation of the real exchange rate from its long run level or to the difference between the domestic and the foreign CPI-inflation rates. In this paper we disentangle the conditions under which these rules may lead to endogenous fluctuations due to self-fulfilling expectations in a small open economy that faces nominal rigidities. We find that besides the specification of the rule, structural parameters such as the share ...
Purchasing power parity: three stakes through the heart of the unit root null
We provide a comprehensive analysis of the purchasing power parity hypothesis, relying on a linear panel data framework. First, we consider two panel unit root tests, based on transformations of country-specific statistics, which allow for parameter heterogeneity across countries. Using GLS techniques, we modify the two tests to eliminate the upward size distortion induced by cross-sectional dependence among contemporaneous real exchange rate innovations. Second, we consider two tests based on a fixed-effects specification: these tests allow for cross-sectional dependence but impose parameter ...
Violating purchasing power parity.
This paper demonstrates that deviations from the law of one price are an important source of violations of absolute PPP across countries. Using highly disaggregated U.S. export data, we document evidence of systematic international price discrimination based on the local wage of consumers in the destination market. We show that most violations from absolute PPP can also be explained by international differences in wages. We find very little additional explanation is due to differences in income per capita. Developing and calibrating a model of pricing-to-market based on search frictions and ...