Working Paper
“Conditional PPP” and Real Exchange Rate Convergence in the Euro Area
Abstract: While economic theory highlights the usefulness of flexible exchange rates in promoting adjustment in international relative prices, flexible exchange rates also can be a source of destabilizing shocks. We find that when countries joining the euro currency union abandoned their national exchange rates, the adjustment of real exchange rates toward their long-run equilibrium surprisingly became faster. To investigate, we distinguish between differing rates of purchasing power parity (PPP) convergence conditional on alternative shocks, which we refer to as ?conditional PPP.? We find that the loss of the exchange rate as an adjustment mechanism after the introduction of the euro was more than compensated by the elimination of the exchange rate as a source of shocks, in combination with faster adjustment in national prices. These findings support claims that flexible exchange rates are not necessary to promote long-run international relative price adjustment.
JEL Classification: F00; F15; F31;
https://doi.org/10.24148/wp2016-29
Access Documents
File(s):
File format is application/pdf
http://www.frbsf.org/economic-research/files/wp2016-29.pdf
Description: Full text
Authors
Bibliographic Information
Provider: Federal Reserve Bank of San Francisco
Part of Series: Working Paper Series
Publication Date: 2016-10-18
Number: 2016-29
Pages: 39 pages
Note: This draft: October 18, 2016