0321316762_IM_15 - Chapter 15 Price Levels and the Exchange...

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Chapter 15 Price Levels and the Exchange Rate in the Long Run T Chapter Organization The Law of One Price Purchasing Power Parity The Relationship Between PPP and the Law of One Price Absolute PPP and Relative PPP A Long-Run Exchange-Rate Model Based on PPP The Fundamental Equation of the Monetary Approach Ongoing Inflation, Interest Parity, and PPP The Fisher Effect Empirical Evidence on PPP and the Law of One Price Box: Some Meaty Evidence on the Law of One Price Explaining the Problems with PPP Trade Barriers and Nontradables Departures from Free Competition Differences in Consumption Patterns and Price Level Measurement PPP in the Short Run and in the Long Run Box: Sticky Prices and the Law of One Price: Evidence From Scandinavian Duty-free Shops Case Study: Why Price Levels are Lower in Poorer Countries Beyond Purchasing Power Parity: A General Model of Long-Run Exchange Rates The Real Exchange Rate Demand, Supply, and the Long-Run Real Exchange Rate Nominal and Real Exchange Rates in Long-Run Equilibrium International Interest Rate Differences and the Real Exchange Rate Real Interest Parity Summary Appendix: The Fisher Effect, the Interest Rate, and the Exchange Rate under the Flexible-Price Monetary Approach
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80 Krugman/Obstfeld • International Economics: Theory and Policy, Seventh Edition T Chapter Overview The time frame of the analysis of exchange rate determination shifts to the long run in this chapter. An analysis of the determination of the long-run exchange rate is required for the completion of the short-run exchange rate model since, as demonstrated in the previous two chapters, the long-run expected exchange rate affects the current spot rate. Issues addressed here include both monetary and real-side determinants of the long-run real exchange rate. The development of the model of the long-run exchange rate touches on a number of issues, including the effect of ongoing inflation on the exchange rate, the Fisher effect, and the role of tradables and nontradables. Empirical issues, such as the breakdown of purchasing power parity in the 1970s and the correlation between price levels and per capita income, are addressed within this framework. The law of one price, which holds that the prices of goods are the same in all countries in the absence of transport costs or trade restrictions, presents an intuitively appealing introduction to long-run exchange rate determination. An extension of this law to sets of goods motivates the proposition of absolute purchasing power parity. Relative purchasing power parity, a less restrictive proposition, relates changes in exchange rates to changes in relative price levels and may be valid even when absolute PPP is not. Purchasing power parity provides a cornerstone of the monetary approach to the exchange rate, which
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This note was uploaded on 05/18/2010 for the course ECON 203 taught by Professor Kim during the Spring '10 term at Korea University.

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0321316762_IM_15 - Chapter 15 Price Levels and the Exchange...

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