Pass-through of exchange rates and purchasing power parity

In this paper we develop and test two hypotheses about purchasing power parity (PPP). The first is that changes in the price of traded goods relative to domestic substitutes will affect the PPP relation, due to the partial pass-through of exchange rates. The second is that PPP should hold on forward...

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Bibliographic Details
Published in:Journal of international economics 1997-08, Vol.43 (1), p.237-261
Main Authors: Feenstra, Robert C., Kendall, Jon D.
Format: Article
Language:English
Subjects:
Business strategies
Economic theory
Exchange rates
Foreign exchange rates
Forward rate
Hypotheses
Imperfect competition
Interest rate differential
Interest rates
Manycountries
Pass-through
Prices
Purchasing power
Purchasing power parity
Statistical analysis
Studies
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Summary:In this paper we develop and test two hypotheses about purchasing power parity (PPP). The first is that changes in the price of traded goods relative to domestic substitutes will affect the PPP relation, due to the partial pass-through of exchange rates. The second is that PPP should hold on forward rather than spot exchange rates, due to hedging by firms, which implies that the interest rate differential should enter the PPP relation for spot rates. Using quarterly data for several countries, we find support for both these hypotheses, though the magnitude of the interest rate effect is very small.
ISSN:0022-1996
1873-0353
DOI:10.1016/S0022-1996(96)01473-0