Working Paper: NBER ID: w1591
Authors: Rudiger Dornbusch
Abstract: The paper is a survey of PPP theory and evidence prepared for the New Palgrave dictionary of economics. Following a statement of the absolute and relative versions of the theory, there is a brief sketch of the history of thought with emphasis on Cassel and the monetary approach. A theoretical part distinguishes structural and transitory deviations from PPP. The main basis for structural deviations is the Ricardo-Harrod-Balassa-Samuelson model of productivity differentials that affect the real prices of home goods and hence real price levels. Transitory deviations emerge from differential speeds of goods and assets markets. In particular sticky wages combined with imperfect competition or spatial discrimination in pricing give rise to sometimes persistent movements in real exchange rates. After an overview of empirical evidence the paper concludes with a review of implications of PPP disparities. Applications to international real income comparisons, interest rate linkages and exchange rate policy receive attention.
Keywords: Purchasing Power Parity; Exchange Rates; International Economics
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| market integration (F02) | price equalization (P22) |
| transport costs and trade barriers (F14) | deviations from absolute PPP (F31) |
| monetary disturbances (E39) | exchange rates deviations from PPP (F31) |
| inflation rates (E31) | exchange rates (F31) |
| productivity differentials (O49) | long-term deviations from PPP (F31) |
| higher productivity (O49) | higher relative price levels (P22) |
| structural changes in the economy (L16) | weak form of PPP (F31) |
| shifts in demand or changes in trade patterns (F12) | exchange rate behavior (F31) |