Working Paper: CEPR ID: DP1128
Authors: Jeffrey A. Frankel; Andrew K. Rose
Abstract: Previous time-series studies have shown evidence of mean-reversion in real exchange rates. Deviations from purchasing power parity (PPP) appear to have half-lives of approximately four years. The long samples required for statistical significance are unavailable for most currencies, however, and may be inappropriate because of regime changes. In this study, we re-examine deviations from PPP using a panel of 150 countries and 45 annual observations. Our panel shows strong evidence of mean-reversion that is similar to that from long time-series. PPP deviations are eroded at a rate of approximately 15% annually, i.e. their half-life is around four years. Such findings can be masked in time-series data, but are relatively easy to find in cross-sections.
Keywords: long-run; cross section; time series; real exchange rate; inflation; variation
JEL Codes: F30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| PPP deviations (C59) | mean reversion of PPP deviations (F31) |
| mean reversion of PPP deviations (F31) | half-life of PPP deviations (F31) |
| cross-sectional estimates (C21) | mean reversion coefficient (C29) |
| inflation differentials (E31) | percentage change in exchange rates (F31) |