2. RUSDincreases (why?) 3. EUSD/EURfalls (why? IP) = dollar appreciates
(a) U.S. money supply, (b) Dollar interest rate,
235-455.4. Empirical evidence on PPP and the Law of One Price•on Fisher effect: largely OK- evolution- level•on absolute PPP (and law of one price): very poor•on relative PPP (see Fig. 5-x2): poor- more or less proportional move until 1970- but after 1970 ...•conclusion:- empirical evidence is weak- PPP appears to be of little use, even as a long-run explanation of exchange rate movements5-465.5. Explaining the problems with PPP (p. 147)Reasons why PPP may not be accurate: the law of one price may not hold because of 1. Trade barriers and nontradable products 2. Imperfect competition 3. Differences in measures of average prices for baskets of goods and services
24 5-47 Shortcomings of PPP (cont.) • Trade barriers and nontradable products – Transport costs and governmental trade restrictions make trade expensive and in some cases create nontradable goods or services. – Services are often not tradable: services are generally offered within a limited geographic region (for example, haircuts). – The greater the transport costs, the greater the range over which the exchange rate can deviate from its PPP value.
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