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Purchasing power parity puzzle as a trade phenomenon Berka, Martin

Abstract

The purchasing power parity puzzle is among the central issues of international macroeconomics. In my thesis, I document and explain the persistence and volatility of its empirical counterpart - the real exchange rate - as a trade phenomenon arising from heterogeneous physical characteristics of products and geography. In the first chapter, a general equilibrium model with shipping costs that depend on physical characteristics of goods and distance leads to endogenous tradability of goods. Deviations of prices from parity are sustained as long as they do not exceed the heterogeneous trade frictions. The real exchange rate exhibits deviations whose persistence matches the data and, when quadratic adjustment costs in change of trade volume are added to the model, also the volatility of the real exchange rate deviations matches the data as well. The second chapter studies monthly deviations from the law of one price for a group of 63 goods and services in Canada and USA between 1970 and 2000 and relates them to a separate dataset of price-toweight and price-to-volume ratios. Threshold estimates are significantly negatively related to the estimates of the price-to-weight ratios and price-to-volume ratios, respectively. Physical characteristics of goods are important empirical determinants of heterogeneous non-linear behavior of deviations of their prices from parity. The third chapter studies the implications for monetary policy in a general equilibrium model where credit crunches occur due to shifts in the distribution of assets among heterogeneous households.

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