A behavioral explanation for the puzzling persistence of the aggregate real exchange rate

At the aggregate level, evidence that deviations from purchasing power parity (PPP) are too persistent to be explained solely by nominal rigidities has long been a puzzle (Rogoff, 1996). Another micro price of law one (LOP), which is basic building block PPP, LOP less than PPP deviations. To reconcile empirical evidence, we adapt model behavioral inattention in Gabaix (2014, 2020) simple two-country sticky-price model. We propose test and find strong its favor using data US Canadian cities. Calibrating with our estimates, show reconciles two puzzles relating LOP. First, more twice as only sticky prices. Second, decrease two-thirds degree persistence.