Purchasing power parity: Evidence from developing Countries

This paper utilizes the dynamic error-correction model (DECM) to examine the issue of purchasing power parity (PPP) for 11 developing countries (Argentina, Bolivia, Colombia, Cote d'Ivoire, Ecuador, Guatemala, Kenya, Nigeria, Peru, South Africa, and Venezuela). For comparison purposes, evidence from the traditional unit root methods of the augmented Dickey-Fuller (ADF) and Phillips-Perron is presented. The results from the conventional unit root tests failed to find evidence of PPP in all of the cases. However, the results from the generalized error-correction model detected evidence of PPP for nine out of the 11 countries under consideration. Based on these results, it was concluded that PPP holds in the long-run for the sample countries and that the implicit restrictions associated with unit root tests prevented earlier studies from finding evidence in support of PPP theory.The views expressed in this paper are those of the authors only. They do not reflect the views of the World Bank.     

Long‐Run PPP under the Presence of Near‐to‐Unit Roots: The Case of the British Pound–US Dollar Rate*

Empirical tests typically provide evidence that the British pound–US dollar exchange rate and the relative wholesale price index contain exact unit roots and exhibit cointegration. However, the cointegrating vector is significantly different from [1, ?1], thus raising doubts on the validity of the purchasing power parity (PPP) hypothesis. Following Elliott (1998 ), we show that if the exchange rate and relative price series contain near‐to‐unit roots in the context of a bivariate system, then any inference on the “cointegrating” vector and consequently on PPP, which is based on standard cointegration estimation methods, will be misleading. We then argue that the existing evidence against the PPP hypothesis in the British pound–US dollar market can be attributed to the finite sample bias of the standard cointegration estimators, arising from an endogenous and “nearly” nonstationary regressor. We also show that when robust procedures are employed the evidence favors the PPP hypothesis.     

Removal of farm subsidies in a regional economy: a computable general equilibrium analysis

There are a number of studies that examine the purchasing power parity (PPP) hypothesis. The empirical findings from the extant literature for the PPP hypothesis are mixed. This article applies univariate and panel Lagrange Multiplier (LM) unit root tests with one and two structural breaks to real exchange rates for 15 Asian countries. The univariate LM unit root tests find evidence of PPP for two-thirds of the sample. The results from the panel LM unit root test support long-run PPP for the Asian countries in the sample. The results from the LM panel unit root tests differ from those of existing panel unit root tests of PPP for Asian countries that have not allowed for the existence of structural breaks.     

Are PPP tests erratically behaved? Some panel evidence

This paper examines whether, in addition to standard unit root and cointegration tests, panel approaches also produce test statistics behaving erratically when applied to tests for Purchasing Power Parity (PPP). We show that if appropriate tests (which are robust to cross‐sectional dependence) are used, any evidence of erratic behaviour disappears, and empirical support is found for PPP.     

Digging out the PPP hypothesis: an integrated empirical coverage

We use several popular tests to test the validity of the Purchasing Power Parity (PPP) hypothesis. In particular, we analyze four classes of tests??standard univariate unit root tests, co-integration, panel unit root tests, and unit root tests for nonlinear frameworks??for a dataset consisting of 20 bilateral exchange rates. Through this approach, we ascertain the effectiveness of each methodology in assessing the validity of PPP. Overall, our results suggest little evidence to support PPP. Among the conducted tests, the Panel Analysis of Nonstationarity in the Idiosyncratic and Common components (PANIC) provides the richest insights by disentangling the possible sources of non-stationarity of real exchange rates. The relevance of using price indices with different characteristics is also pinpointed.     

PPP: Further evidence from Japanese regional data

This paper empirically analyzes Purchasing Power Parity (PPP) among Japanese municipalities from 1990 to 2003. Using panel unit root tests including one that considers cross-sectional dependence in the data (e.g., [Moon, H. R. and Perron, B. (2004). Testing for a unit root in panels with dynamic factors. Journal of Econometrics, 112, 81–126.]), we find evidence in favor of PPP, confirming the stationarity of relative prices in Japan and thus the long-run co-movement of municipal prices. Furthermore, the half-life of a shock is found to be about 2 years, which is faster than that of the international PPP. As in the European and US studies, short-term deviations from PPP can be explained by income differentials and distance between cities.     

Testing the purchasing power parity in panel data

This paper empirically tests the purchasing power parity (PPP) using panel unit root tests. We employ a battery of panel unit root tests: LM-bar statistic [Testing for unit roots in heterogeneous panels, Working paper, University of Cambridge] is employed to account for serially correlated errors. The statistic proposed by Breitung [Adv. Econom. 15 (2000) 161.] and the KPSS-based statistic of Hadri [Econ. J. 3 (2000) 148.] are also used. In addition, we also employ a SUR estimator to account for possible cross-sectional effect. Data of 45 economies from 1980 to 1999 are used to test the PPP hypothesis. We find that these estimators tend to get supportive results when the data frequency becomes lower, which substantially characterizes the long-run property of the PPP hypothesis.     

Asymmetry dynamics in real exchange rates: New results on East Asian currencies

This paper provides new evidence on the purchasing power parity (PPP) hypothesis in six East Asian countries. Based on nonlinear unit root tests, we discovered that the results are broadly consistent with the fact that real exchange rates (RERs) follow a nonlinear mean reversion process. We presented new evidence that the adjustment towards the PPP parity is asymmetric (LSTAR process) above and below the equilibrium value in all but one case — the Malaysian ringgit (MYR). The empirical results suggest that it is important that the conventional tests of PPP be amended to take account of asymmetries in the adjustment process in RERs.     

A managerial model of investment: overlooked alternatives

The long-run purchasing power parity (PPP) hypothesis is tested for nine bilateral sterling exchange rates, using recently developed techniques on cointegration and seasonal integration. The empirical findings show that none of the exchange rates and relative prices contain seasonal unit roots, but all have an autoregressive unit root. The cointegration tests overwhelmingly reject the PPP hypothesis as a long-run equilibrium condition for all countries concerned.     

人民币汇率与购买力平价的互动关系:——一个VEC模型分析

文章基于Johansen协整检验和向量误差修正模型估计,研究了人民币汇率与购买力平价的长期互动关系。结论显示,人民币汇率取决于购买力平价,也反过来影响购买力平价,汇率变动对价格来说具有显著的渠道效应。因此,购买力平价可以作为确定人民币均衡汇率的一种参照,但在确定人民币汇率调整路径时,应该考虑汇率对国际相对价格、尤其是本国价格的潜在影响。     

Does purchasing power parity hold sometimes? Regime switching in real exchange rates

Standard unit root tests are not very powerful in drawing conclusions regarding the validity of Purchasing Power Parity (PPP). Rather than asking whether PPP holds throughout the whole sample period, we examine, in this study, if PPP holds sometimes by employing Hamilton-type (1989) Markov regime switching models. When at least one of multiple regimes is stationary, PPP holds locally within the regime. There are indeed various reasons that we should expect that the persistence of real exchange rates changes over time. Employing five real exchange rates spanning more than 100 years, we find herein strong evidence that the strength of PPP varies during the sample periods and that there exist stationary regimes in which PPP holds. Throughout the article, we also make comparisons to previous Markov regime switching estimation results by Kanas (2006) on the same data series. The new Markov switching model selection criterion of Smith et al. (2006), which is devised especially for discriminating Markov regime switching models, unambiguously indicates a preference for the Hamilton-type Markov regime switching model employed in this study. We also find that the evidence for PPP is not much different across different nominal exchange rate arrangements.     

An error correcting model of farmland prices

Granger has demonstrated that if two variables are integrated of order one and are conitegrated, they can be modelled as having been generated by an error correction mechanism. Cointegration and error correction systems allow long-run components of variables to obey equilibrium constraints while short-run components are allowed to have flexible dynamic specification. Using data from five Corn Belt States in the US, we show that farmland prices and cash rents are each integrated of order one and are model is estimated. The error correction term is found to be significant in both equations, indicating Granger causality running in both directions. Historical simulation of the model is performed. The price equation peroformed better although both equations simulate reasonably well.     

Revisiting purchasing power parity for African countries: with nonlinear panel unit-root tests

This study applies Panel Seemingly Unrelated Regressions (SUR) Kapetanios et al. (Kapetanios–Shin–Snell (KSS), SURKSS) tests, proposed by Wu and Lee (2009), to investigate the properties of long-run Purchasing Power Parity (PPP) in 15 African countries. The empirical results from the univariate unit root and panel based unit root tests indicate that PPP does not hold for these 15 countries under study. However, Panel SURKSS tests indicate that PPP is valid for four of these 15 countries. These results have important policy implications for these 15 African countries under study.     

Panel asymmetric nonlinear unit root test and PPP in Africa

This study revisits purchasing power parity (PPP) theory for 20 African countries using panel asymmetric nonlinear unit root test proposed by Emirmahmutoglu and Omay (2014), through the sequential panel selection method of Chortareas and Kapetanios (2009). While standard panel unit root tests fail to support the PPP, the empirical results from panel asymmetric nonlinear unit root test do support the PPP. However, additional tests reveal that support in all 20 African countries is mostly due to stationarity of the real effective exchange rates of Ghana and Rwanda where the adjustment process towards equilibrium is nonlinear and asymmetric.     

Small sample properties of Canonical Cointegrating Regressions

Monte Carlo simulations are performed to examine small sample properties of Canonical Cointegrating Regressions (CCR). The first data generation process is designed to generate both cointegrated and non-cointegrated systems with normal disturbances. If the near-observational equivalence of the stationary and the integrated processes is not significant, both powers and empirical sizes of CCR tests are acceptable. The second data generation process is based on the error correction model. Cointegrated systems with various fat-tailed disturbances are generated and analyzed. The empirical sizes of CCR tests with studentt disturbances and GARCH disturbances are found to be reasonable under certain restrictions. The last data generation process is a generalized least squares (GLS) process that incorporates heteroskedasticity into the error correction model. Again, the empirical sizes of CCR tests are reasonable.     

Purchasing power parity and country characteristics: Evidence from panel data tests

We examine long-run purchasing power parity (PPP) using panel data methods to test for unit roots in US dollar real exchange rates of 84 countries. We find stronger evidence of PPP in countries more open to trade, closer to the United States, with lower inflation and moderate nominal exchange rate volatility, and with similar economic growth rates as the United States. We also show that PPP holds for panels of European and Latin American countries, but not for African and Asian countries. Our findings demonstrate that country characteristics can help explain both adherence to and deviations from long-run PPP.     

Exchange rate and long run equilibrium in transition economies

The purpose of this paper is to calculate pruchasing power parity rates and the real exchange rate using several methods of calculation to estimate long-run equilibrium real exchange rates in transition economies, mainly in Eastern European countries considered in transition, such as Poland. The authors calculate different measures of exchange rate misalignment (absolute and relative deviations from long-run equilibrium). Each measure is calculated using different price indices, which include consumer price indices, GDP deflactor, and unit labor cost. The expected values of these variables are used. To calculate the long-run equilibrium, different methods such as an error correction equation and a forward-looking model are utilized, and again, the expected values of the variables are introduced along with new variables. The estimation of the long-run cointegration equation of the equilibrium real exchange rate and the corresponding dynamic error correction specification strongly corroborates the model and produced fairly consistent results across the countries under study. Using appropriated proxies, the estimated long run equations were used to derive indices of the equilibrium real exchange rate.     

Purchasing power parity for 15 Latin American countries: Panel SURKSS test with a Fourier function

This study applies Panel SURKSS test with a Fourier function to investigate the properties of long-run purchasing power parity (PPP) in fifteen Latin American countries over the period of December 1994 to February 2010. The empirical results from the univariate unit root and panel-based unit root tests indicate that PPP does not hold for these fifteen countries under study. However, results from the Panel SURKSS test with a Fourier function indicate that PPP is valid for these fifteen countries, with the exception of Honduras. Our results highlight the importance of incorporating both nonlinearities and structural breaks when testing the validity of long-run PPP. These results have important policy implications for these fifteen Latin American countries under study.     

Re-examination of the long-run purchasing power parity: further evidence from Turkey

In this article, we re-examine the empirical validity of the Purchasing Power Parity (PPP) theory for the Turkish economy. For this purpose, an empirical model is constructed using some contemporaneous estimation techniques such as multivariate co-integration and vector error correction methodology. Our estimation results reveal that the PPP can strongly be supported as a long-run stationary steady-state relationship for the Turkish economy.     

Government revenue,government expenditure,and temporal causality: evidence from China

Dissatisfied with little evidence provided on various hypotheses concerning the revenue-expenditure relation in China, this paper is an empirical endeavour to fill the gap through a battery of econometric tests for causality based on vector error correction and vector autoregression models. A more comprehensive testing strategy for unit roots and cointegration has been suggested, and a bidirectional causality pattern has been found in China's government finance. The paper thus concludes that attempts simply to change revenue or expenditure or both without taking into account of the interdependence between the two may be counter-productive, and the effects on aggregate demand of government debt-financing in the presence of inflation may not be as detrimental as some economists would expect.