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The Economics of Exchange Rates (Collected Works of Harry Johnson) by Harry G. Johnson, Jacob A. Frenkel

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CHAPTER 4

CONTRACTING AND SPURIOUS DEVIATIONS FROM PURCHASING-POWER PARITY

STEPHEN P. MAGEE

The University of Texas at Austin

The movement to floating exchange rates has been an important development in our understanding of the interaction between goods markets and securities markets. International trade data permit a comparison of the efficiency of goods markets relative to securities markets which is not possible using domestic data. Each transaction in international trade involves both a real and a financial market.

For example, with perfect efficiency and the absence of transactions costs in both markets, the ratio of the home price to the foreign price (called the “goods price ratio”) will equal the units of home currency per foreign currency ...

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