Abstract
This paper investigates the empirical determinants of purchasing power parity (PPP) deviations over the recent period of flexible exchange rates. Transitory PPP deviations arise in a world in which prices are sticky, but where exchange rates respond instantaneously to news. Permanent PPP deviations occur when price indices differ across countries, and the world is subject to real shocks. Regressions, consistent with the hypothesis that current exchange rate changes create immediate PPP deviations which are slowly dissipated but not eliminated, imply that both sticky prices and real shocks are responsible for the recent failure of PPP.
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