Nonlinear Adjustment to Purchasing Power Parity in the post-Bretton Woods Era
Christopher F. Baum
This paper models the dynamics of adjustment to long-run purchasing power parity (PPP) over the post-Bretton Woods period in a nonlinear framework consistent with the presence of frictions in international trade. We estimate exponential smooth transition autoregressive (ESTAR) models of deviations from PPP using both CPI- and WPI-based measures for a broad set of U.S. trading partners. We find clear evidence of a mean-reverting dynamic process for sizable deviations from PPP, with an equilibrium tendency varying nonlinearly with the magnitude of disequilibrium.
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