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PURCHASING POWER PARITY VERSUS FIXED EXCHANGE RATE RULES: A STABILITY AND WELFARE ANALYSIS *
Author(s) -
SHIN JONG KOOK,
SUBRAMANIAN CHETAN
Publication year - 2012
Publication title -
the manchester school
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.361
H-Index - 42
eISSN - 1467-9957
pISSN - 1463-6786
DOI - 10.1111/j.1467-9957.2011.02244.x
Subject(s) - economics , purchasing power parity , exchange rate , uniqueness , welfare , fixed cost , econometrics , fixed interest rate loan , relative purchasing power parity , stability (learning theory) , microeconomics , macroeconomics , mathematics , interest rate , computer science , market economy , mathematical analysis , machine learning
This paper evaluates the desirability of PPP rules vis‐á‐vis fixed exchange rates both in terms of welfare and stability properties. The analysis is conducted within a small open‐economy New Keynesian framework extended to include a cost channel. In terms of stability, we find that while the equilibrium is always unique under fixed exchange rates its uniqueness critically depends upon the presence/absence of the cost channel under a PPP rule. Overall, then, in terms of welfare a fixed exchange rate always outperforms a PPP rule.