THE LAW OF ONE PRICE, PURCHASING POWER PARITY AND EXCHANGE RATES
- Author(s): Pippenger, John
- et al.
Exchange-rate economics is filled with puzzles. The asset approach has failed. Purchasing Power Parity is useful at best in the long run. There is no clear link between exchange rates and fundamentals. With no empirically supported theory for exchange rates, open-economy macro models are built on sand. This paper shows for the first time how recognizing differences between retail, wholesale and auction markets helps solve the puzzles, provides a theory of exchange rates based on auction markets for assets and commodities, and suggests a link between fundamentals and exchange rates.