Working Paper: NBER ID: w4842
Authors: Robert C. Feenstra; Jon D. Kendall
Abstract: In this paper we develop and test two hypotheses about purchasing power parity (PPP) derived from the pricing behavior of profit- maximizing, exporting firms. The first is that changes in the price of traded goods relative to domestic substitutes, due to partial pass- through of exchange rates, will affect the PPP relation. The second is that PPP should hold on forward rather than spot exchange rates, due to hedging by firms. Using quarterly data for the United States, Canada, France, Germany, Japan and the United Kingdom, we find considerable support for the first but not the second hypothesis.
Keywords: Purchasing Power Parity; Exchange Rates; Passthrough; International Trade
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| price of traded goods relative to domestic substitutes (F16) | PPP relation (H44) |
| partial passthrough of exchange rates (F31) | price of traded goods relative to domestic substitutes (F16) |
| interest rate differentials (E43) | deviations from PPP (F31) |
| PPP should hold on forward rates (E43) | PPP should hold on spot rates (F31) |