EMANUELE BACCHIOCCHI AND LUCA FANELLI

SUMMARY
This paper contributes to the empirical literature on the purchasing power parity (PPP) over the post-Bretton
Woods period by providing a time-series based interpretation of the controversial evidence characterizing the
dynamics of real exchange rates. It is shown that the persistence of deviations from the PPP between a set
of European countries and the United States may be empirically attributed to the presence of I(2) stochastic
trends in prices using Consumer Price Indices. Interestingly, the slow adjustment towards the equilibrium can
be modelled through ‘integral-proportional’ equilibrium correction models and this evidence can be partly
reconciled with theories where the inflation rate reduces the markup of profit-maximizing firms acting on
imperfectly competitive markets. Copyright  2005 John Wiley & Sons, Ltd.