Purchasing power parity and exchange rates: Another look at the evidence

This paper examines some of the evidence on the relationship between prices and exchange rates, looking at data from the 1920s and the 1970s. Simple regression tests lead us to reject the hypothesis of purchasing power parity. These tests are, however, inappropriate when, as is usually the case, neither prices nor the exchange rate may be taken as exogenous. Tests which recognize the endogeneity of both prices and exchange rates give results considerably more favorable to purchasing power parity. Tests which recognize the endogeneity of both prices and exchange rates give results which, while not definitive, are more favorable to the purchasing power parity hypothesis.