NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

PPP Strikes Back: Aggregation and the Real Exchange Rate

Jean Imbs, Haroon Mumtaz, Morton O. Ravn, Helene Rey

NBER Working Paper No. 9372
Issued in December 2002
NBER Program(s):   IFM

We show the importance of a dynamic aggregation bias in accounting for the PPP puzzle. We prove that established time series and panel methods substantially exaggerate the persistence of real exchange rates because of heterogeneity in the dynamics of disaggregated relative prices. When heterogeneity is properly taken into account, estimates of the real exchange rate half-life fall dramatically, to little more than one year, or significantly below Rogoff's consensus view' of three to five years. We show corrected estimates are consistent with plausible nominal rigidities, thus, arguably, solving the puzzle. We also explain why traded goods prices account for the bulk of the persistence and volatility of the real exchange rate. The reason is that traded goods prices display dynamics that are more heterogeneous than non-traded ones.

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Document Object Identifier (DOI): 10.3386/w9372

Published: Jean Imbs & Haroon Mumtaz & Morten Ravn & Hélène Rey, 2005. "PPP Strikes Back: Aggregation and the Real Exchange Rate," The Quarterly Journal of Economics, MIT Press, vol. 120(1), pages 1-43, January. citation courtesy of

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