NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Modeling Deviations from Purchasing Power Parity (PPP)

Joshua Aizenman

NBER Working Paper No. 1066 (Also Reprint No. r0509)
Issued in 1983
NBER Program(s):   ITI   IFM

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 monotonic. 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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Document Object Identifier (DOI): 10.3386/w1066

Published: Aizenman, Joshua. "Modeling Deviations from Purchasing Power Parity (PPP)." International Economic Review, Vol. 25, No. 1, (February 1984), pp. 175- 191.

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