Abstract
Persistent departures from purchasing power parity (PPP) since the demise of the Bretton Woods system have been well documented by many scholars, including Frenkel (1976) Kravis, Heston, and Summers (1982), and Kravis andLipsey (1983, 1987, 1988). Forexample, Kravis, Heston, and Summers found large departures from PPP for thirty-four countries in 1975, that is, some LDC price levels were about one-third the U.S. price level. In addition, Kravis and Lipsey found that most of the cross-country deviations from PPP can be explained by differences in per capita real GDPs. Wealthier countries tend to have relatively higher price levels, after adjusting for exchange rates. The literature on the disequilibrium approach to exchange rates as in Dombusch (1987), and Frenkel and Rodriguez (1982), can explain short-run exchange rate volatility and short-run deviations from PPP. However, these models generate a movement toward PPP in the long run, and, hence, are inconsistent with the stylized facts. Because of this, Lucas (1978) and Stockman (1982, 1987) have developed an equilibrium approach to exchange rates that allows for pennanent departures from PPP. However, the focus of the equilibrium approach has been on the long-run comparative statics solutions to open economy models, with little attention to exchange rate dynamics and the effect, if any, of such dynamics on the long-run equilibrium. A key element in the analysis below is the well-known idea that the equilibrium solution to a model will be altered if transactions take place when the system is temporarily out of equilibrium, provided that: (i)
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.