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Global Interdependence, Decoupling, and Recoupling$
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Yin-Wong Cheung and Frank Westermann

Print publication date: 2013

Print ISBN-13: 9780262019804

Published to MIT Press Scholarship Online: May 2014

DOI: 10.7551/mitpress/9780262019804.001.0001

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The Penn Effect: Decoupling and Recoupling in the Price-Income Relationship?

The Penn Effect: Decoupling and Recoupling in the Price-Income Relationship?

(p.263) 12 The Penn Effect: Decoupling and Recoupling in the Price-Income Relationship?
Global Interdependence, Decoupling, and Recoupling

Eiji Fujii

The MIT Press

This chapter considers the issue of decoupling and recoupling through a window of the well-known positive relationship between national price and per capita income levels. Specifically, it investigates time evolution of the income effect on price, known as the Penn effect, while focusing on its differential between developed countries and developing countries. In so doing, it explores ramifications of the recent data revisions by the World Bank. The results reveal significant time variation in the Penn effect, irrespective of the data revision. Further, the findings show that the Penn effect consists of the common effect for all countries, and the effect shared exclusively by developed countries. Importantly, it can be seen that the widely documented positive cross-country price-income association is driven mostly by the effect specific to developed countries. Developing countries, however, also start exhibiting significant but much milder effect in the 1980s or as late as the mid-1990s, depending on the data vintages. To identify the sources of the observed variations in the Penn effect, the chapter further examines implications of trade and financial regimes using nontradables share, trade and financial openness, and exchange rate regimes as controls. While the variables affect national price levels, their differences do not sufficiently account for either the developed-developing country differential or the time variation of the Penn effect. To illustrate the implications of the findings in concrete terms, the study applies the price-income regression in the context of currency misalignment evaluation.

Keywords:   Absolute purchasing power parity, Balassa-Samuelson model, International comparison program, Misalignment, Penn effect

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