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1、CHAPTER 15 PRICE LEVELS AND THE EXCHANGE RATE IN THE LONG RUN Chapter OrganizationThe Law of One PricePurchasing Power ParityThe Relationship Between PPP and the Law of One PriceAbsolute PPP and Relative PPPA Long-Run Exchange-Rate Model Based on PPPThe Fundamental Equation of the Monetary ApproachO
2、ngoing Inflation, Interest Parity, and PPPThe Fisher EffectEmpirical Evidence on PPP and the Law of One PriceBox: Some Meaty Evidence on the Law of One PriceExplaining the Problems with PPPTrade Barriers and NontradablesDepartures from Free CompetitionBox: Hong Kongs Surprisingly High InflationInter
3、national Differences in Price Level MeasurementPPP in the Short Run and in the Long RunBox: Sticky Prices and the Law of One Price: Evidence From Scandinavian Duty-free ShopsCase Study: Why Price Levels are Lower in Poorer CountriesBeyond Purchasing Power Parity: A General Model of Long-Run Exchange
4、 RatesThe Real Exchange RateDemand, Supply, and the Long-Run Real Exchange Rate Nominal and Real Exchange Rates in Long-Run EquilibriumCase Study: Why Has the Yen Keep Rising?International Interest Rate Differences and the Real Exchange RateReal Interest ParitySummaryAppendix: The Fisher Effect, the
5、 Interest Rate, and the Exchange Rate under the Flexible-Price Monetary ApproachCHAPTER OVERVIEW The time frame of the analysis of exchange rate determination shifts to the long run in this chapter. An analysis of the determination of the long-run exchange rate is required for the completion of the
6、short-run exchange rate model since, as demonstrated in the previous two chapters, the long-run expected exchange rate affects the current spot rate. Issues addressed here include both monetary and real-side determinants of the long-run real exchange rate. The development of the model of the long-ru
7、n exchange rate touches on a number of issues, including the effect of ongoing inflation on the exchange rate, the Fisher effect, and the role of tradables and nontradables. Empirical issues, such as the breakdown of purchasing power parity in the 1970s and the correlation between price levels and p
8、er capita income, are addressed within this framework. The law of one price, which holds that the prices of goods are the same in all countries in the absence of transport costs or trade restrictions, presents an intuitively appealing introduction to long-run exchange rate determination. An extensio
9、n of this law to sets of goods motivates the proposition of absolute purchasing power parity. Relative purchasing power parity, a less restrictive proposition, relates changes in exchange rates to changes in relative price levels and may be valid even when absolute PPP is not. Purchasing power parit
10、y provides a cornerstone of the monetary approach to the exchange rate, which serves as the first model of the long-run exchange rate developed in this chapter. This first model also demonstrates how ongoing inflation affects the long-run exchange rate.The monetary approach to the exchange rate uses
11、 PPP to model the exchange rate as the price level in the home country relative to the price level in the foreign country. The money market equilibrium relationship is used to substitute money supply divided by money demand for the price level. The Fisher relationship allows us to substitute expecte
12、d inflation for the nominal interest rate. The resulting relationship models the long-run exchange rate as a function of relative money supplies, the inflation differential and relative output in the two countries;E = (M/M*)l(pe - p*e, (Y*/Y)The l function represents the ratio of foreign to domestic
13、 money demand; thus, both the difference in expected inflation rates and the output ratio enter the function with a positive sign. An increase in inflation at home means higher home interest rates (through the Fisher equation) and lower home money demand. An increase in foreign output raises foreign
14、 money demand.One result from this model that students may find initially confusing concerns the relationship between the long-run exchange rate and the nominal interest rate. The model in this chapter provides an example of an increase in the interest rate associated with exchange rate depreciation
15、. In contrast, the short-run analysis in the previous chapter provides an example of an increase in the domestic interest rate associated with an appreciation of the currency. These different relationships between the exchange rate and the interest rate reflect different causes for the rise in the i
16、nterest rate as well as different assumptions concerning price rigidity. In the analysis of the previous chapter, the interest rate rises due to a contraction in the level of the nominal money supply. With fixed prices, this contraction of nominal balances is matched by a contraction in real balances. Excess money demand is resolved through a rise in interest rates which is associated with an appre
