The Adjustment of Prices and the Adjustment of the Exchange Rate / Charles Engel, James C. Morley.

Format:

Book

Author/Creator:

Engel, Charles.

Contributor:

National Bureau of Economic Research.

Morley, James C.

Series:

Working Paper Series (National Bureau of Economic Research) no. w8550.

NBER working paper series no. w8550

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2001.

Summary:

The purchasing power parity puzzle relates to the adjustment of real exchange rates. Real exchange rates are extremely volatile, suggesting that temporary shocks emanate from the monetary sector. But the half-life of real exchange rate deviations is extremely large -- 2.5 to 5 years. This half-life seems too large to be explained by the slow adjustment of nominal prices. We offer a different interpretation. We maintain that nominal exchange rates and prices need not converge at the same rate, as is implicit in rational-expectations sticky-price models of the exchange rate. Evidence from an unobserved components model for nominal prices and nominal exchange rates that imposes relative purchasing power parity in the long run indicates that nominal exchange rates converge much more slowly than nominal prices. The real puzzle is why nominal exchange rates converge so slowly.

Notes:

Print version record

October 2001.