NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The 'Real' Explanation of the PPP Puzzle

Nicholas Ford, Charles Yuji Horioka

NBER Working Paper No. 22198
Issued in April 2016
NBER Program(s):   IFM   ITI

This article shows that global financial markets cannot, by themselves, achieve net transfers of financial capital and real interest rate equalisation across countries and that the integration of both global financial markets and global goods markets is needed to achieve net transfers of capital and real interest rate equalisation across countries. Thus, frictions (barriers to mobility) in one or both of these markets can impede the net transfer of capital between countries, produce the Feldstein and Horioka (1980) finding of high saving-investment correlations, and prevent real interest rates from being equalised across countries. Moreover, frictions in global goods markets can explain why real exchange rates deviate from PPP (purchasing power parity) for extended periods of time and can therefore also explain the PPP puzzle. Thus, we are able to resolve 2 of Obstfeld and Rogoff’s (2000) “6 major puzzles in macroeconomics” with essentially the same explanation.

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Document Object Identifier (DOI): 10.3386/w22198

Published: Nicholas Ford & Charles Yuji Horioka, 2017. "The ‘real’ explanation of the PPP puzzle," Applied Economics Letters, vol 24(5), pages 325-328.

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