“Conditional PPP” and Real Exchange Rate Convergence in the Euro Area


Paul R. Bergin

Jyh-Lin Wu

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2016-29 | October 1, 2016

While economic theory highlights the usefulness of flexible exchange rates in promoting adjustment in international relative prices, flexible exchange rates also can be a source of destabilizing shocks. We find that when countries joining the euro currency union abandoned their national exchange rates, the adjustment of real exchange rates toward their long-run equilibrium surprisingly became faster. To investigate, we distinguish between differing rates of purchasing power parity (PPP) convergence conditional on alternative shocks, which we refer to as “conditional PPP.” We find that the loss of the exchange rate as an adjustment mechanism after the introduction of the euro was more than compensated by the elimination of the exchange rate as a source of shocks, in combination with faster adjustment in national prices. These findings support claims that flexible exchange rates are not necessary to promote long-run international relative price adjustment.

Article Citation

Wu, Jyh-Lin, Paul R. Bergin, and Reuven Glick. 2016. ““Conditional PPP” and Real Exchange Rate Convergence in the Euro Area,” Federal Reserve Bank of San Francisco Working Paper 2016-29. Available at https://doi.org/10.24148/wp2016-29

About the Author
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Reuven Glick is a group vice president in the Economic Research Department of the Federal Reserve Bank of San Francisco. Learn more about Reuven Glick