A Prism into the PPP Puzzles: The Micro-foundations of Big Mac Real Exchange Rates / David C. Parsley, Shang-Jin Wei.

Format:

Book

Author/Creator:

Parsley, David C.

Contributor:

National Bureau of Economic Research.

Wei, Shang-Jin.

Series:

Working Paper Series (National Bureau of Economic Research) no. w10074.

NBER working paper series no. w10074

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

A Prism into the PPP Puzzles

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2003.

Summary:

The real exchange rate (RER) has been called the single most important price, yet its behavior exhibits several puzzles. In this project, we use Big Mac prices as a unique prism to study the movement of real exchange rates. Part of our innovation is to match these prices to the prices of individual ingredients. There are a number of advantages associated with our approach. First, unlike the CPI RER, we can measure the Big Mac RER in levels. Second, unlike the CPI RER, for which the attribution to tradable and non-tradable components involves assumptions on the weights and the functional form, we (almost) know the exact composition of a Big Mac, and can estimate the tradable and non-tradable components relatively precisely. Third, we can study the dynamics of the RER in a setting free of: the product-aggregation bias, the temporal aggregation bias, and the bias generated by non-compatible consumption baskets across countries. Fourth that Engel's result that deviations from the law of one price are sole explanation for RER movements does not hold generally. We offer some evidence that departure from the Engel effect can be systematically linked to economic factors.

Notes:

Print version record

November 2003.