Lecture 12: SOURCES OF DEVIATIONS FROM PURCHASING POWER PARITY (PPP)

Transcription

1 Lecture 12: SOURCES OF DEVIATIONS FROM PURCHASING POWER PARITY (PPP) Barriers to International Integration Transportation costs Tariffs & non-tariff trade barriers Border frictions Currencies. Non-Traded Goods The relative price of NTGs The Balassa-Samuelson Effect Deviations from the Balassa-Samuelson line.

2 Barriers to International Integration Long distance transport costs fell sharply during the late 19th century. Real Freight Rates for Jute from Calcutta to UK (1884=1.00) Saif I. Shah Mohammed & Jeffrey G. Williamson, 2004, "Freight rates and productivity gains in British tramp shipping " Explorations in Economic History 41.2:

3 By 1914, low transport costs, UK-led free trade, & the Pax Brittanica allowed arbitrage between the US & UK in wheat.

4 Agricultural products still feature high trade barriers, preventing price arbitrage.

5 CROSS-BORDER TRADE BARRIERS: KEY FINDINGS (after controlling for trade policy & geographic variables) Gravity model of volume of trade shows: Evidence of arbitrage in price differentials shows: Even across the Canadian- U.S. border, firms trade with fellow citizens 20 x as much as cross-border (5 x, after controlling for FTA, etc.) -- McCallum (1995); Helliwell (1998). frictions in crossing the border >> frictions in going from one end of country to the other -- Engel & Rogers (1996). Looking at trade among a large sample of countries, a difference in currencies, in particular, cuts trade by 3 -- Rose (2000). different currencies, in particular, explain some of the border frictions -- Parsley & Wei (2001); Cavallo, Neiman & Rigobon (2014).

6 Engel & Rogers How Wide is the Border? AER (1996) Crossing the border, e.g., from Vancouver to Seattle, adds more friction into price arbitrage than traveling the length of the continent from Atlantic to Pacific.

7 Andrew Rose, 2000, One Money, One Market? The Effect of Currencies on International Trade, Economic Policy. The gravity model of bilateral trade shows that such barriers as distance, tariffs, borders, etc., still matter. Rose (2000): A reduction in bilateral exchange rate variability encourages trade. More surprisingly, joining a currency union results in an estimated tripling of trade among the partners, even after controlling for colonial history, etc., (exp(1.2)=3).

8 NonTraded Goods & Services Why is the cost of living so high in Tokyo and so low in Mumbai? Why was Buenos Aires in 2001 more expensive than Paris or Frankfurt?...

9 In 2004, Tokyo was still very expensive. But Buenos Aires had fallen far below Paris or Frankfurt. Why? The peso collapsed in 2002.

10 The real exchange rate varies with each country s relative price of NTGs. Q (E)(CPI ) (CPI) E (P TG 1 α P NTG α ) (P TG 1 α P NTG α ) where α weight of NTGs in price basket. EP TG (P TG α P NTG α ) (P TG ) (P TG α PNTG α ) assuming arbitrage works for TGs. Q = (P NTG /P TG )α (P NTG /PT G ) α

11 One important application of TG/NTGs, esp. for long-run trends. The Balassa-Samuelson effect: (P NTG /P TG ) -- and therefore 1/Q -- rises with countries real incomes. The usual B-S reason: Productivity growth takes place in the TG sector, reducing prices there relative to wages and P NTG. The statistical relationship between income per capita and the absolute real exchange rate is well documented. Some cross-section studies: the original Balassa article (1964) Rogoff (1996): = recent studies of RMB undervaluation (see appendix 2). (.09) (.04) It takes more work to verify that productivity growth operates via the relative price of NonTraded Goods. E.g., DeGregorio, Giovannini & Wolf (1994).

12 The original Belassa article showed 1960 levels.

13 Distinguishng TGs from NTGs is difficult in practice. Estimates of tradability calculated for about 200 products, as the worldwide trade/output ratio, relative to average tradability of all products If more than 2% of the sector is traded, it must be tradable. Tradable goods Non- Tradable Goods Data: 20 OECD countries, , from UNIDO (2000) & US.Commerce Dept. (2002). Source: Robert E. Lipsey & Birgitta Swedenborg, 2010, Review of World Economics.

14 De Gregorio, Giovannini & Wolf (1994), International Evidence on Tradables and Nontradables Inflation In almost all countries, the ratio of NTG prices to TG prices rises over time ( Baumol s cost disease ). Japan had the strongest trend during the post-war period.

15 The countries with the strongest productivity growth tend to show the strongest upward trend in the relative prices of NTGs ( ).

16 Balassa-Samuelson relationship: Absolute price levels are higher in rich countries (real exchange rates are lower). 1/Q G.Alessandria & J. Kaboski, 2008, Why are Goods So Cheap in Some Countries? Bus.Rev, Fed.Res. Bank of Philadelphia, Q2. Fig.1

17 Balassa-Samuelson relationship re-estimated Every 1% increase in real income/capita is associated on average with.38% real appreciation. In any given year, many countries lie far off the line. E.g., China s RMB appeared undervalued, even relative to the B-S relationship, by 25% in What causes currencies to deviate from the B-S line? Devaluation/revaluation, or Fixed nominal exchange rate plus inflation or rapid productivity growth. But gaps from the B-S line tend to correct 1/2-way per decade.

18 API Macroeconomic Policy Analysis I Professor Jeffrey Frankel, Kennedy School of Government, Harvard University

19 APPENDIX 1 -- PASSTHROUGH Jose Campa & Linda Goldberg (2005) Passthrough of exchange rate changes to import prices is low into the US market (especially in the SR). But for most other countries, the passthrough coefficient is above 50% even in the SR, and not statistically different from 1 in the LR. In most, the coefficient fell during the 1990s. Compositional differences of price indices (e.g., more weight on oil vs. autos) can alone explain part of the variation in passthrough coefficients. The passthrough coefficient depends on inflation & exchange rate volatility.

20 Jose Campa & Linda Goldberg, 2005, Exchange Rate Pass Through into Import Prices," Review of Econ. & Stats.

21 APPENDIX 2: VALUATION OF CHINA S RMB Balassa-Samuelson estimated for 2000 Cross-section of 118 countries Fitted values logrer00 CHN Log of real exchange value of country s currency (1/Q) CHN loginc00 Log of real income 3 paths to an undervalued currency: (i) devaluation, (ii) low inflation, (iii) fixed exchange rate during a long period of rapid productivity growth. Frankel (2006): On the Yuan: The Choice Between Adjustment Under a Fixed Exchange Rate and Adjustment under a Flexible Rate, Understanding the Chinese Economy, G.Illing, ed. (OUP).

22 Balassa-Samuelson estimated for 2005 The Balassa-Samuelson Relationship Log of Real Per capita GDP (PPP) coef = , (robust) se = , t = Source: Arvind Subramanian (2010), PB10-08, Peterson Institute for International Economics. Undervaluation of the 2005 RMB in the estimated regression = 26%. Compare to estimate for 2000 (Frankel 2005): 36%. 22 As recently as 2009 (Chang 2012) : 25%.

23 Balassa-Samuelson estimated for 2011 In 2014, the ICP released new absolute price data. Is the Renminbi Still Undervalued? Not According to New PPP Estimates by M.Kessler & A.Subramanian, PIIE, May 2014 Benchmark years GDP per capita (in PPP dollars) RMB undervaluation (percent) , ,

24 Estimate APPENDIX of 1 overvaluation/undervaluation measured Balassa- relative to the Balassa-Samuelson line Samuelson for relationship Source: Gene Chang Theory and Refinement of the Enhanced-PPP Model for Equilibrium Exchange Rates, China: 25% undervaluation The RMB continued to appreciate in real terms. It has approximately completed its adjustment, as also shows up in the trade balance.