Purchasing Power Parity and New Trade Theory
February 1, 2002
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Summary
This paper theoretically derives and empirically tests the implications of a new trade theory framework for the systematic movements in the real exchange rate. It focuses on the effect of imperfect substitutability of tradables and on the importance of competitiveness, for which we construct an original proxy. Using a panel dynamic OLS estimation of nine bilateral US dollar real exchange rates, we derive long-run coefficients for relative productivity and competitiveness in the tradable and non-tradable sectors, controlling for standard macroeconomic variables. The implications of imperfect substitutability of tradables fit the data better than the standard neoclassical assumption of price equalization. Our new measure of competitiveness is statistically significant in explaining deviations from PPP.
Subject: Competition, Financial markets, Financial services, Foreign exchange, Labor, Production, Productivity, Real exchange rates, Real interest rates, Wages
Keywords: coefficient restriction, Competition, competitiveness term, New trade theory, Productivity, productivity differentials, productivity in tradables, productivity of non-tradables, productivity of tradables, productivity term, purchasing power parity, real exchange rates, Real interest rates, the PPP puzzle, utility function, Wages, WP
Pages:
35
Volume:
2002
DOI:
Issue:
032
Series:
Working Paper No. 2002/032
Stock No:
WPIEA0322002
ISBN:
9781451845129
ISSN:
1018-5941
