Is the relationship between prices and exchange rates homogeneous? |
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Institution: | 1. Technical University Munich, 85748 Garching, Germany;2. School of Economics and Management, Leibniz University Hannover, Königsworther Platz 1, 30167 Hannover, Germany;3. University of Liverpool Management School, Chatham Street, Liverpool, L69 7ZH, UK |
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Abstract: | Empirical tests of purchasing power parity (PPP) are implicitly based on the conditions of symmetry and proportionality of the price coefficients. We investigate a separate condition, which we term homogeneity. Specifically, while there may be factors that drive a wedge between prices and exchange rates, when these factors are held constant we would expect a change in exchange rates to be associated with a proportional, or homogeneous, change in prices. To test for the existence of homogeneity in prices, we conduct two experiments. First, we apply a time-varying-coefficient procedure to nine euro-area countries as well as the euro area as a whole during the (monthly) sample period, 1999:M1 to 2011:M3. Second we apply the same procedure to the same group of countries, plus Canada, Japan and Mexico, over the longer period, 1957:M4 to 2011:M3. We find that averages of the price coefficients, corrected for specification biases, are uniformly homogeneous in the long run, providing strong support for PPP. |
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Keywords: | Purchasing power parity Symmetry Proportionality Homogeneity Generalized cointegration Time-varying coefficients C32 F31 |
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