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A Prism into the PPP Puzzles: The Micro-Foundations of Big Mac Real Exchange Rates

David C. Parsley and Shang-Jin Wei
The Economic Journal
Vol. 117, No. 523 (Oct., 2007), pp. 1336-1356
Published by: Wiley on behalf of the Royal Economic Society
Stable URL: http://www.jstor.org/stable/4625557
Page Count: 21
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A Prism into the PPP Puzzles: The Micro-Foundations of Big Mac Real Exchange Rates
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Abstract

We match Big Mac prices with prices of its ingredients as a unique prism to study real exchange rates (RERs). This approach has several advantages. First, the levels of the Big Mac RER can be measured meaningfully. Second, as the exact composition of a Big Mac is known, the contributions of its tradable and non-tradable components can be estimated relatively precisely. Third, the dynamics of the RER can be studied in a setting free of several biases inherent in CPI-based RERs. Finally, a large cross-country dimension allows us to overturn the Engel result on what drives RERs.

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