Structural Determinants of Real Exchange Rates and National Price Levels: Some Empirical Evidence

  • Bergstrand J
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Contrary to the long-held notion of purchasing power parity (PPP), economists have found systematic evidence that the general level of prices across countries at a point in time varies dramatically, as of March 1991. Researchers Irving B. Kravis, Alan W. Heston, and Robert Summers, for example, report that some countries' national price levels are no more than one-third the U.S. price level. Extensions of this work shows that such departures from PPP have persisted for decades. Recently, efforts have been made to explain systematically these persistent, or structural, departures from PPP. Pioneering work by Kravis and Robert E. Lipsey has demonstrated that a positive correlation between the price level and real per capita gross domestic product is robust across numerous cross-sectional specifications. For instance, using data from Kravis et al., 87 percent of the variation in national price levels of 21 countries' in 1975 is explained by per capita gross domestic product and a constant. Although researcher Christopher Clague showed that other "structural" characteristics have significant explanatory power when also included, why per capita has such a robust empirical correlation to the price level and what economic factors it represents have not yet been determined.

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  • Jeffrey H. Bergstrand

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