Deviation of the purchasing power parity hypothesis and equilibrium real exchange rate: Chile 1986-2011
Abstract
The fact that the Purchasing Power Parity hypothesis (PPP) is not confirmed in the short and medium term is a widely discussed macroeconomic puzzle. The evidence for the Chilean economy suggests that only in the very long term it is possible to find evidence in favor of the PPP hypothesis. The main causes of these deviations from the law of a unique price would be short term nominal rigidities, changes in the exchange rate regime and structural breaks in RER. These deviations could impact the measurement of the equilibrium RER, and therefore the understanding of the RER dynamics becomes of particular relevance in terms of economic policy. This paper studies the RER dynamics, finding evidence of a potential structural break in its trajectory between the years 1998 and 1999. The cause of the break would be related to the implementation of the inflation targeting cum flexible exchange rate regime. Through the resolution of a DSGE model estimated for Chile, I propose an alternative methodology for the calculation of the equilibrium RER.
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