Revisiting Purchasing Power Parity in OECD

This study revisits Purchasing Power Parity theory (PPP) in the 34 OECD countries during January 1994–August 2013. We use a new panel stationary test with both sharp breaks and smooth shifts, a novel approach to panel unit-root testing, proposed by Bahmani–Oskooee et al. (2014). The results indicate that the PPP holds in half of the 34 OECD countries. These results indicate the importance of proper modelling of both sharp breaks and smooth shifts in real effective exchange rate series of OECD countries.     

Testing for Sunspot in the Foreign Exchange Market

It has been shown that the nonfundamental uncertainty called sunspots matters in many areas of the economy. Noting the fact that nationwide capital movement and the speculative demand for foreign currencies are rapidly increasing, this paper conducts empirical tests on the sunspot exchange rate model. The empirical result shows that the sunspot equilibrium exchange rate deviating from Purchasing Power Parity (PPP) and Interest Rate Parity (IRP) is consistent with the real data. More importantly, the Generalized Method of Moments (GMM) over-identification test is shown to support the evidence that more general Euler equations are in favor of our sunspot equilibrium exchange rate model. [C52, E44]     

Testing the presence and the absence of purchasing power parity: results for fixed and flexible regimes

Recent empirical studies concerning purchasing power parity (PPP), using the concept of cointegraton, have tested the null hypothesis of the absence orthe presence of PPP. The disadvantage of using either of these approaches is that the conclusion is ambiguous when not rejecting the null: the result could be due to either the null hypothesis being true or by the low power of the test and lack of information in the data. Therefore, there is substantial information to be gained by applying both approaches within the same study. This study uses the ordinary DF test with PPP as the alternative hypothesis and a recently suggested test by Kwiatkowski et al. (1992) with PPP as the null. The tests are applied to four major industrial countries real exchange rates, each split into four different samples, including fixed as well as flexible exchange rate regimes. The absence of PPP cannot be rejected while the presence can be rejected.     

Purchasing power parity in the short and long run: a reappraisal of the post-1973 evidence

In this paper, an attempt is made to separate the short-run and long-run aspects of the purchasing power parity (PPP) relationship, using the techniques of band-spectral regression and cointegration for eight industrialized countries. The long-run PPP is first tested for all the eight countries, with reference to their nominal bilateral exchange rates vis-à-visthe US dollar. For five European currencies, the analysis is repeated with respect to the Deutschmark, with a separate consideration of the post-EMS period. In the concluding sections, possible reasons for PPP deviations are examined.     

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.     

ARE ASIA‐PACIFIC REAL EXCHANGE RATES STATIONARY? A REGIME‐SWITCHING PERSPECTIVE

This paper tests for long‐run purchasing power (PPP) among nine Asia‐Pacific countries. Non‐stationarity of the real exchange rate is tested within a Markov regime‐switching framework. Two new concepts of PPP are defined that allow for real exchange behaviour to switch between stationary and non‐stationary regimes (partial PPP) or between stationary regimes of differing degrees of persistence (varied PPP). The results indicate that each country is characterized by at least one stationary regime. Indeed, five countries are characterized by two such regimes. Further analysis indicates that the Asian crisis of 1997 gave mixed impetus to the achievement of long‐run PPP.     

The persistence in real exchange rate: Evidence from East Asian countries

In this article, we examine the degree of persistence in monthly real exchange rate of six East Asian countries in relation to their two major trading partners, the United States and Japan, to study the validity of PPP for the 1976:01–2009:03 period. To investigate the persistency in real exchange rate series, we use sum of the autoregressive (AR) coefficients and the confidence interval for it using grid-bootstrap procedure recently developed by Hansen (1999). We have two findings: first, we find evidence for high persistency in real exchange rate in terms of the Japanese yen for five countries and for four countries in terms of the US dollar the for the full and pre-crisis sample periods. Second, for the post-crisis period, the presence of low persistency in real exchange rate supports PPP for three countries in terms of the Japanese yen and five countries in terms of the US dollar. These findings indicate that real exchange rate series of five East Asian countries are mean-revert based on their exchange rate policies and East Asian countries can form a currency union.     

Non-linear quantile unit root test and PPP: more evidence from Africa

It is now a common practice to establish stationarity of the real exchange rate as a sign of purchasing power parity (PPP) hypothesis. In this article, we consider the real effective exchange rates of 29 African countries. When we apply conventional linear unit root tests, we find support for the PPP in eight countries. However, when we shift to the newly introduced non-linear quantile unit root test, support for the PPP increases to 15 countries.     

Testing a theoretical model of mortgage demand on UK data

This study explores whether the long-run purchasing power parity (PPP) hypothesis holds for selected real exchange rates from Turkish economy during the period 1982M1–2003M12. In addition to conventional unit root tests, five different unit root test procedures have been applied including efficient point-optimal tests, extended M tests and GLS-detrended variants of DF tests, to four monthly real exchange rate series defined in terms of both producer and consumer price indices. The countries analysed are the USA, the UK, Germany and Italy which are major trade partners of Turkey. Mixed evidence is found for the long-run PPP hypothesis when real exchange rate is defined in terms of German DM and Italian Lira. However, the empirical analysis reveals that the PPP hypothesis holds strongly in the long-run for the UK£ and US$ based real exchange rates series using either PPI or CPI. In corroboration with other studies in the literature, the bias correlated half-life estimates suggest relatively faster speeds of adjustment supporting the view that the deviations from the PPP rate dissipate rather quickly for relatively high inflation countries.     

Real and nominal effective exchange rates for 22 LDCs: 1971:1–1990:4

The International Monetary Fund constructs and publishes the real and nominal effective exchange rates, mostly for developed but not less developed countries. This paper employs a method of constructing real and nominal effective exchange rate from the literature to produce quarterly data over the 1971–1990 period for 22 developing nations. As an application, the stationarity of real effective exchange rates are determined to establish the empirical validity of the Purchasing Power Parity Theory (PPP). The results reveal that PPP fails to hold for most countries.     

The real exchange rate and the black market exchange rate in developing countries

This article tests for the validity of the Purchasing power parity (PPP) theory using both the black market and the official exchange rates for panels with cross sectional dependency. The test is conducted using a newly developed, nonlinear IV panel unit root test that properly handles cross-sectional dependency for thirty-seven developing countries. We find that the null of joint unit root hypothesis is rejected for the whole panel, using the black market exchange rate, and for sub-panels of African and high inflation countries, using either exchange rate. The black market-based real exchange rates are, therefore, shown to provide stronger evidence for the purchasing power parity theory than do the official rates. This finding is consistent with the observation that black market exchange rates better represent market forces and thus are more relevant when testing for the validity of the PPP theory in developing countries.     

Exchange rate uncertainty and US bilateral fresh fruit and fresh vegetable trade: an application of the gravity model

In order to analyse the effect of exchange rate uncertainty, we apply an empirical gravity equation to two sets of US bilateral trade data: fresh fruit over the period 1976–1999 for a panel of 26 countries; and fresh vegetables over the period 1976–2006 for a panel of nine countries. Based on panel estimation methods, and using both a moving SD measure and the Perée and Steinherr (1989) measure of exchange rate uncertainty, the results show that US bilateral fresh fruit trade has been negatively affected by exchange rate uncertainty. We also find some evidence that the exchange rate between the US dollar and the currencies of Latin American trading partners accounts for most of the negative impact of exchange rate uncertainty on bilateral trade flows in fresh fruit. In contrast, when using panel estimation methods and both measures of exchange rate uncertainty, we find no statistically significant evidence for any negative effect of exchange rate uncertainty on US bilateral fresh vegetable trade. However, we do find a statistically significant negative effect for exchange rate uncertainty when we estimate a US export gravity equation for fresh vegetables using the same panel of countries.     

Further evidence on purchasing power parity and country characteristics

Using data from 76 countries, this paper investigates the relationship between country characteristics and the validity of purchasing power parity (PPP). Several interesting results are obtained based on dollar-based exchange rates. First, PPP holds for Africa and Latin America. Further, PPP tends to be supported for countries with high or moderate openness, low growth rates, high inflation rates and high nominal exchange rate volatility, respectively. Second, a single country characteristic seems inadequate to account for the validity of PPP. Third, PPP is supported if countries satisfy at least two characteristics of supporting PPP simultaneously. Finally, the main results of the paper are robust when the numeraire currency changes from the US dollar to Japanese yen.     

Purchasing power parity and real factors

It is acknowledged that purchasing power parity (PPP) fails in empirical tests. The position adopted is that real factors are an omitted variable from the PPP relationship and are the cause of divergences from PPP. The real exchange rate as being determined by supply and demand shift factors (as in Stockman, 1987 and Neary, 1988) is modelled. We then empirically estimate a real exchange rate equation and use the fitted value as a generated regressor in tests of PPP. It is demonstrated that when changes in the real exchange rate are incorporated into the PPP relationship, PPP improves.     

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.     

Threshold cointegration and purchasing power parity in the pacific nations

The paper uses a threshold cointegration methodology to explore the properties of long-run purchasing power parity (PPP) in the Pacific nations. Using Japan and the USA as base countries, it is shown that long-run PPP holds for most Asian countries but that the adjustment mechanism is asymmetric. In contrast to symmetric error-correction models, it is found that asymmetric adjustments of nominal exchange rates play an important role in eliminating deviations from long-run PPP.     

PPP in the medium run: The case of Norway

Existing studies generally reject purchasing power parity (PPP) on data sets from countries that have been affected by large real shocks, including Norway. However, we offer strong evidence of PPP between Norway and its trading partners during the post-Bretton Woods period, in which the Norwegian economy has experienced numerous real shocks such as discoveries of large petroleum reserves and oil price shocks. In particular, the behavior of the Norwegian real and nominal exchange rates appears remarkably consistent with the PPP theory. Moreover, convergence towards PPP is relatively rapid; the half-life of a deviation from parity is just about 1.5 years. We show that such deviations are primarily eliminated by adjustments in the nominal exchange rate and we offer some explanations for the relatively rapid convergence towards PPP.     

Purchasing Power Parity When Prices Are I(2)

This paper examines the purchasing power parity (PPP) hypothesis over the modern float using data on 15 OECD currencies. Evidence is presented that suggests the price levels evolve as second-difference stationary processes, i.e., integrated of order two ( P₁– I (2)). A necessary condition for PPP when prices are I (2) is that prices are cointegrated across countries to an I (1) relative price. In general this relative price is not the same as the simple price ratio. For some of the relationships examined, this relative price level is cointegrated with the exchange rate, implying a long-run equilibrium between nominal exchange rates and prices.     

Nonlinear adjustment in PPP—evidence from threshold cointegration

Nonlinearity in PPP has been carefully reported in number of studies. However, asymmetry with respect to the sign of the deviation and the dependency of the asymmetry on the exchange rate regime has largely remained outside the scope of those studies. The present paper partly fills this gap. It applies threshold cointegration techniques to real exchange rate dynamics between two Nordic countries, Finland and Sweden. First, it examines whether the sign of the deviation from equilibrium has any impact on adjustment. Second, it estimates an asymmetric band-type threshold cointegration in PPP. The results supported asymmetric adjustment in PPP. The single, asymmetric threshold indicated stronger adjustment during the flexible exchange rate regime. The band-type asymmetric threshold cointegration suggested that adjustment towards PPP would be fastest within the estimated band, which was interpreted as evidence for the target zone exchange rate regime. Accordingly, the inference on adjustment is sensitive to the type of nonlinearity used.I am grateful to the editor and two anonymous referees for many helpful comments and suggestions.