Nonlinear Adjustment to Purchasing Power Parity in the post-Bretton Woods Era
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Nonlinear Adjustment to Purchasing Power Parity in the post-Bretton Woods Era Christopher F. Baum Department of Economics Boston College John T. Barkoulas Department of Economics and Finance Louisiana Tech University Mustafa Caglayan Department of Economics and Finance University of Durham, UK This paper models the dynamics of adjustment to long-run PPP over the post-Bretton Woods period in a nonlinear framework consistent with the presence of frictions in international trade. We estimate exponential smooth transition autoregressive (ESTAR) models of deviations from PPP, which are obtained using the Johansen cointegration method, for both CPIand WPIbased measures and a broad set of U.S. trading partners. In several cases, we 1nd clear evidence of a mean-reverting dynamic process for sizable deviations from PPP, with the equilibrium tendency varying nonlinearly with the magnitude of disequilibrium. Analysis of impulse response functions also supports a nonlinear dynamic structure, but convergence to long-run PPP in the post-Bretton Woods era is very slow. JEL: F32, C22.
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