TY  - JOUR
AU  - Engel,Charles
AU  - Morley,James C.
TI  - The Adjustment of Prices and the Adjustment of the Exchange Rate
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 8550
PY  - 2001
Y2  - October 2001
UR  - http://www.nber.org/papers/w8550
L1  - http://www.nber.org/papers/w8550.pdf
N1  - Author contact info:
Charles Engel
Department of Economics
University of Wisconsin
1180 Observatory Drive
Madison, WI  53706-1393
Tel: 608/262-3697
Fax: 608/262-2033
E-Mail: cengel@ssc.wisc.edu
AB  - The purchasing power parity puzzle relates to the adjustment of real exchange rates. Real exchange rates are extremely volatile, suggesting that temporary shocks emanate from the monetary sector. But the half-life of real exchange rate deviations is extremely large -- 2.5 to 5 years. This half-life seems too large to be explained by the slow adjustment of nominal prices. We offer a different interpretation. We maintain that nominal exchange rates and prices need not converge at the same rate, as is implicit in rational-expectations sticky-price models of the exchange rate. Evidence from an unobserved components model for nominal prices and nominal exchange rates that imposes relative purchasing power parity in the long run indicates that nominal exchange rates converge much more slowly than nominal prices. The real puzzle is why nominal exchange rates converge so slowly.
ER  -