Persistence in Law-of-One-Price Deviations: Evidence from Micro-data

Abstract

We study the dynamics of good-by-good real exchange rates using a micro-panel of 270 goods prices drawn from major cities in 71 countries and 245 goods prices drawn from 13 major U.S. cities. We find half-lives of deviations from the Law-of-One-Price for the average good is about 1 year; somewhat lower for U.S. cities and somewhat higher for cities in the OECD with LDC cities in between. This speed of adjustment is well below the consensus range of estimates of 3 to 5 years for purchasing power parity deviations yet consistent with plausible `price-stickiness.' We further construct price indices using our micro data and find that aggregation bias combined with small sample bias accounts for a large part of the difference between micro and macro estimates for the OECD.