The Purchasing Price Parity states that international relative price differentials should be arbitraged away so that identical goods in different countries should sell for the same price, when expressed in a common currency. Yet the evidence from the empirical literature shows that not only are relative prices quite different across countries, but also such deviations are highly volatile and persistent. These characteristics of the real exchange rate have been the central puzzle in international macroeconomics literature, with the source of the puzzling behavior remaining unclear. (The rest is omitted.)

Abstract

I. Introduction

II. The Model
1. The Economic Environment
2. The Relative Prices of the Traded and Nontraded Goods
3. The Real Exchange Rate

III. Quantitative Evaluation
1. Calibration
2. The Results
3. Sensitivity Analysis

IV. Conclusions

References

Appendix