The real exchange rate and the Purchasing Power Parity puzzle: further evidence

Abstract

This study presents additional evidence on the convergence speeds of real exchange rates. Using median unbiased estimation, impulse response analysis and long horizon data sampled annually and monthly, we estimate the speeds at which deviations from purchasing power parity (PPP) die out. Both monthly and annual data have been used since temporal aggregation has been proposed as a possible cause of the implausibly large half-lives reported in the literature. Moreover, since reporting only point estimates provides an incomplete picture of the speed of convergence towards PPP, median unbiased confidence intervals are also estimated. The results show that the confidence intervals for the half-lives are typically very wide. Interestingly, however, the intervals estimated using monthly data are tighter than those estimated with annual data, though, they do not help solve the PPP puzzle. In fact, it appears that the point estimates of the half-lives obtained with monthly data are much larger. Therefore, on the basis of the evidence reported in this study, the results on temporal aggregation by Taylor (2001) are unlikely to have a major role in empirically explaining the PPP puzzle.

Real Exchange Rate Persistence: Evidence From the Western Offshoots*

“…The PPI is heavily weighted towards tradable goods. The relative price computed from the PPI might be close to the actual exchange rate (see Taylor and Taylor, 2004;Sekioua and Karanasos, 2006…”