Paya, Ivan and Venetis, I. and Peel, David (2003) Further Evidence on PPP Adjustment Speeds: the Case of Effective Real Exchange Rates and the EMS. Oxford Bulletin of Economics and Statistics, 65 (4). pp. 421-437. ISSN 0305-9049Full text not available from this repository.
Two different approaches intend to resolve the ‘puzzling’ slow convergence to purchasing power parity (PPP) reported in the literature [see Rogoff (1996), Journal of Economic Literature, Vol. 34.] On the one hand, there are models that consider a non-linear adjustment of real exchange rate to PPP induced by transaction costs. Such costs imply the presence of a certain transaction band where adjustment is too costly to be undertaken. On the other hand, there are models that relax the ‘classical’ PPP assumption of constant equilibrium real exchange rates. A prominent theory put together by Balassa (1964, Journal of Political Economy, Vol. 72) and Samuelson (1964 Review of Economics and Statistics, Vol. 46), the BS effect, suggests that a non-constant real exchange rate equilibrium is induced by different productivity growth rates between countries. This paper reconciles those two approaches by considering an exponential smooth transition-in-deviation non-linear adjustment mechanism towards non-constant equilibrium real exchange rates within the EMS (European Monetary System) and effective rates. The equilibrium is proxied, in a theoretically appealing manner, using deterministic trends and the relative price of non-tradables to proxy for BS effects. The empirical results provide further support for the hypothesis that real exchange rates are well described by symmetric, nonlinear processes. Furthermore, the half-life of shocks in such models is found to be dramatically shorter than that obtained in linear models.
|Journal or Publication Title:||Oxford Bulletin of Economics and Statistics|
|Subjects:||H Social Sciences > HB Economic Theory|
|Departments:||Lancaster University Management School > Economics|
|Deposited On:||17 Jul 2012 13:38|
|Last Modified:||24 Jan 2017 03:17|
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