Purchasing Power Disparity During the Floating Rate Period: Exchange Rate Volatility, Trade Barriers and Other Culprits

42 Pages Posted: 13 Jul 2000 Last revised: 3 Apr 2022

See all articles by Shang-Jin Wei

Shang-Jin Wei

Columbia University - Columbia Business School, Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

David C. Parsley

Vanderbilt University – Finance and Economics

Date Written: February 1995

Abstract

Using a panel of 12 tradable sectors in 91 OECD country pairs (14 countries), we study the deviations from the purchasing power parity during the recent floating exchange rate period. (1) We find some evidence that the deviations are positively related to exchange rate volatility as well as to transportation costs. (2) Once we have controlled for these two factors, free trade areas such as the EC and the EFTA do not seem to reduce significantly the deviations from PPP relative to other OECD countries. (3) Although only using the post- 1973 data, we are able to find strong evidence of mean reversion towards PPP. The estimated half lives of the deviation from PPP are about four years and three quarters for the non-EMS countries in the sample, and four years and one quarter for the EMS countries. (4) We find evidence of non-linearity in the rate of mean reversion: the convergence occurs faster for country pairs with larger initial deviations.

Suggested Citation

Wei, Shang-Jin and Parsley, David C., Purchasing Power Disparity During the Floating Rate Period: Exchange Rate Volatility, Trade Barriers and Other Culprits (February 1995). NBER Working Paper No. w5032, Available at SSRN: https://ssrn.com/abstract=225811

Shang-Jin Wei (Contact Author)

Columbia University - Columbia Business School, Finance ( email )

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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David C. Parsley

Vanderbilt University – Finance and Economics ( email )

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