Nonlinear adjustment to purchasing power parity in the post-Bretton Woods era

This paper models the dynamics of adjustment to long-run purchasing power p arity (PPP) over the post-Bretton Woods period in a nonlinear framework con sistent with the presence of frictions in international trade. We estimate exponential smooth transition autoregressive (ESTAR) models of deviations f rom PPP, which are obtained using the Johansen cointegration method, fur bo th consumer pl ice index (CPI) and wholesale price index (WPI) based measur es and a broad set of US trading partners. In several cases, we find clear evidence of a mean-reverting dynamic process for sizable deviations from PP P, with the equilibrium tendency varying nonlinearly with the magnitude of disequilibrium. Analysis of impulse response functions also supports a nonl inear dynamic structure, but convergence to long-run PPP in the post-Bretto n Woods era is very slow. (C) 2001 Elsevier Science Ltd. All rights reserve d.