Working Paper: NBER ID: w10607
Authors: Alan M. Taylor; Mark P. Taylor
Abstract: Originally propounded by the sixteenth-century scholars of the University of Salamanca, the concept of purchasing power parity (PPP) was revived in the interwar period in the context of the debate concerning the appropriate level at which to re-establish international exchange rate parities. Broadly accepted as a long-run equilibrium condition in the post-war period, it was first advocated as a short-run equilibrium by many international economists in the first few years following the breakdown of the Bretton Woods system in the early 1970s and then increasingly came under attack on both theoretical and empirical grounds from the late 1970s to the mid 1990s. Accordingly, over the last three decades, a large literature has built up that examines how much the data deviated from theory, and the fruits of this research have provided a deeper understanding of how well PPP applies in both the short run and the long run. Since the mid 1990s, larger datasets and nonlinear econometric methods, in particular, have improved estimation. As deviations narrowed between real exchange rates and PPP, so did the gap narrow between theory and data, and some degree of confidence in long-run PPP began to emerge again. In this respect, the idea of long-run PPP now enjoys perhaps its strongest support in more than thirty years, a distinct reversion in economic thought.
Keywords: No keywords provided
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| purchasing power parity (PPP) holds (F31) | purchasing power of a unit of currency is equal in both domestic and foreign economies (F31) |
| relative purchasing power parity (PPP) holds (F31) | percentage change in the exchange rate offsets difference in inflation rates (F31) |
| inflation rates between countries (F31) | exchange rate depreciation (F31) |
| transaction costs and behavior of nontraded goods influence (F16) | dynamics of exchange rates (F31) |
| short-run deviations from PPP (F31) | long-run PPP (F31) |
| correlation between relative inflation and exchange rate depreciation (F31) | improves when considering longer time frames (C41) |