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.     

Testing purchasing power parity in a multivariate cointegrating framework

This paper examines a bilateral PPP(Purchasing power parity) relationship between Australia and the 11 major trading countries by means of two alternative econometric techniques-a multivariate cointegrating framework and a band-spectral regression. It is acknowledged that there is no strong evidence that classical PPP holds in all cases. However, the generalized version of PPP holds in all cases, and provides a better explanation of the long-run relations between exchange rates and relative prices.The use of different price indices, i.e CPI and WPI,lead to different estimates and hence different policy implications.     

Fractional cointegration,low frequency dynamics and long-run purchasing power parity: an analysis of the Australian dollar over its recent float

A relatively new but generalized concept of fractional cointegration is applied to shed some light on the validity of purchasing power parity (PPP) as a long-run equilibrium condition, by examining the long-run relationship between quarterly consumer price indices and bilateral exchange rates of the Australian dollar and seven major OECD trading partners, over Australia's recent float. The paper demonstrates that relaxing the condition that the residual from the cointegration equation must be a I(0) process, provides a wide range of cases of parity-reversion with processes that are CI(1,d) with 0 < d < 1. Findings tend to suggest that, while standard tests of cointegration fail to support cointegration between nominal exchange rates, domestic and foreign prices, and thus the empirical favour for PPP as a long-run phenomenon, the fractional cointegration analysis permits deviations from equilibrium to follow a fractionally integrated process and hence captures a much wider class of parity or mean-reversion behaviour. Results are mainly supportive of long-run PPP. Furthermore, an analysis of the short-run dynamics propelling the long-run relationship (through a VECM) reveals that domestic prices are consistently the initial receptor of an exogenous shock to the equilibrium and the long-run equilibrium is restored through the short-run adjustment of the nominal exchange rates. These findings are shown to hold clear policy implications.     

Long-run purchasing power parity revisited: a Monte Carlo simulation

The existence of long-run purchasing power parity (PPP) implies that a cointegration vector of nominal exchange rate, domestic price, and foreign price is expected regardless of using the Engle-Granger two-step method or Johansen maximum likelihood approach. However, this paper has found conflicting results: the Engle-Granger technique tends to reject the long-run PPP hypothesis whereas the Johansen method is generally supportive of long-run PPP. Via Monte Carlo simulations, the present paper finds that the Johansen approach has a bias toward supporting long-run PPP especially under the circumstances in which the assumption of normally or/and independently and identically distributed disturbance terms is violated.     

The Balassa-Samuelson Model: A General-Equilibrium Appraisal*

We derive two key propositions of the Balassa-Samuelson model as long-run balanced growth implications of a neoclassical general equilibrium model. the propositions are that productivity differentials determine international differences in nontradable relative prices and deviations from PPP reflect differences in nontradable prices. Closed-form solutions are obtained and tested using panel methods applied to long-run components of OECD sectoral data computed using the Hodrick-Prescott filter. the results indicate that labor productivity differentials help explain international low-frequency differences in relative prices. However, predicted nontradable relative prices are less successful in explaining long-run deviations from PPP. Unless very sophisticated indeed, PPP is a misleadingly pretentious doctrine, promising us what is rare in economics, detailed numerical predictions. (Paul A. Samuelson, 1964, p. 153)     

More Evidence in Favor of the Balassa–Samuelson Hypothesis

This study provides additional evidence of a significant long-run relationship between the relative price of nontradables and real output, consistent with the productivity-bias hypothesis of Balassa and Samuelson. The results, however, also indicate that additional permanent supply shocks, specifically real oil prices, need to be considered. In every case, relative prices are significantly affected by permanent innovations in real output and real oil prices. The general lack of evidence of cointegration, however, points to the possibility that additional long-run determinants of relative prices have been omitted.     

An empirical examination of long-run purchasing power parity using cointegration techniques

This paper presents an empirical analysis of long-run purchasing power parity (PPP) for five major exchange rates using recently developed econometric techniques on the cointegration of economic time series. Our empirical results are extremely unfavourable to the PPP hypothesis as a long-run equilibrium condition, even with an allowance made for measurement error and/or tranportation costs. In particular, we are unable to reject the hypothesis of non-cointegration of the exchange rate and relative prices for any of the countries concerned. Far from finding a stable, long-run proportionality between exchange rates and relative prices, our results therefore suggest that they tend to drift apart without bound.     

Cointegration,dynamic structure,and the validity of purchasing power parity in African countries

The purpose of this paper is to test the validity of the purchasing power parity (PPP) in Africa in the context of a multivariate error-correction model. This approach allows for the consideration of long-run elasticities as well as the dynamics of the short-run adjustment of exchange rates to changes in domestic and foreign prices. Monthly data for fourteen African countries are used, and the period examined is 1973:4 through 2007:7 (i.e., 412 observations). Results from long-run cointegration analysis, short-run error correction models, persistence profile analysis and variance decomposition all confirm the validity of PPP in these moderate-to-high inflation countries, where estimates of half-life deviations from PPP are found to be outside the range suggested by Rogoff (1996).     

Is the Engel curve approach viable in the estimation of alternative PPPs?

Conventional estimates of purchasing power parities (PPP) rely on cross-country price data. Using Engel curves, Almås (Am Econ Rev 102:1093–1117, 2012) was, however, able to show that PPPs contain substantial bias. Since constructing conventional estimates is expensive and time consuming, Almås’ idea of employing Engel curves is welcome. This article examines the viability of the Engel curve approach to PPP and its sensitivity to differences in relative prices and preferences by estimating Engel curves not only between countries but also for regions within a given country. My empirical evidence from the United States and Norway suggests that the differences can be problematic, but not sufficiently to discredit the new methodology. A pragmatic approach to PPP estimation between countries that are different is to compute a PPP band, rather than a point estimate. I present a practical example of this using expenditure data from 2001, which yields a band for NOK and US dollar.     

Purchasing Power Parity: A Time Series Analysis of the U.S. and Mexico, 1995–2007

This paper presents indirect evidence that absolute purchasing power parity (PPP) may hold in the long-run between Mexico and the U.S., but due to data limitations, the relationship could not be tested directly. Thus it is not clear if absolute PPP holds in the long run between the U.S. and Mexico. Given that relative PPP is a necessary, but not sufficient, condition for absolute PPP to hold, this study tests the relationship between the change in the log of the exchange rate, and the changes in the log of the U.S. producer price index (PPI) and the Mexican PPI. Here, the absence of relative PPP would indicate that absolute PPP could not hold. Given that all the relevant variables in first difference log are stationary, PPP in its relative form holds and OLS can be applied directly in a VAR model setting, viz., treating all variables initially as potentially endogenous. The estimates indicate one-way Granger causality from the percentage change in the exchange rate to the percentage change in the Mexican price level, which is not an implausible result for an emerging nation such as Mexico which imports a significant fraction of (dollar denominated) intermediate products and capital inputs.     

Structural breaks,cointegration and the farm-retail price spread for lamb

This paper examines the farm—retail price spread for lamb from monthly UK data for 1979–1993. Using cointegration, it examines seasonal patterns in producer and retail prices and seeks to identify a long-run relationship between them. Results show that a long-run relationship exists, and that the direction of Granger-causality is from retail to producer prices. Lamb prices are therefore set in the retail market. Results also show that there is a structural break in the relationship in January 1990 when the price increases; this coincides exactly with a change in policy.     

Residential water demand responds asymmetrically to rising and falling prices

This paper econometrically estimates residential water consumption in Germany between 2007 and 2013 based on a panel of almost 3000 supply areas. In particular, the analysis distinguishes periods of rising and falling water and sewage water prices. The short-run (long-run) price elasticity is estimated at around 4.2% (13%), but water demand appears to respond asymmetrically to rising and falling prices. When prices are rising, the short-run (long-run) price elasticity is around 6.5% (17%). When prices are falling, the short-run price elasticity is not statistically different from zero, and the long-run price elasticity is estimated at around 12%. Additional results illustrate that employing average prices instead of marginal prices results in substantially overestimating the price elasticity. These findings are particularly relevant for utilities and regulators planning to alter the tariff structure towards a higher fixed fee and a lower volumetric fee.     

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.     

The behaviour of relative prices in the European Union: A sectoral analysis

Using multivariate unit root test methods, this paper investigates the Purchasing Power Parity (PPP) hypothesis at the sectoral level across six European countries over the last 17 years. Evidence of mean reversion towards PPP is found for the relative prices of some sectors and countries. Mean reversion in relative prices is explained by cross-country and cross-sectoral characteristics such as the distance between countries, nominal exchange rate volatility, differences in GDP per capita, non-tariff barriers, research and development, advertising, industrial concentration and tradeability of the products.     

FUEL TAXES AND COINTEGRATION OF ENERGY PRICES

Creating a successful energy tax policy requires understanding the markets that the energy policy targets. This paper analyzes coal, natural gas, and oil markets to determine the extent to which these fuel prices move together. Results indicate that a stable long-run relationship between coal and oil prices existed until 1974 and that this relationship changed after 1974. The long-run relationship between coal, natural gas, and oil prices implies that a single fuel tax in these markets would not be effective as a single tax policy. Similarly, an equal percentage tax on these energy sources, which does not change relative prices initially, would not keep relative prices unchanged in the long run. Energy policy must take account of the long-run relationship between different energy prices. Otherwise, the long-run results of energy policy could be quite different than intended .     

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.     

Adjustment costs and factor demands in Canadian manufacturing industries

This paper examines whether there is a relationship between the commodity terms of trade (the price of primary commodities relative to the price of manufactures) and the net barter terms of trade of 42 Sub-Saharan African countries. For most countries, there is little evidence of a stable, long-run relationship between the two terms of trade series. Accordingly, the practice in the literature of proxying for movements in any given country's terms of trade by using an aggregate index of relative commodity prices is inappropriate, and is likely to engender misleading policy conclusions.     

Measuring the distance between relative price vectors of different countries

A simple measure is developed for the distance between relative price vectors. It is applied to cross-country data. The procedure also provides a justification for the use of geometric mean prices in cross-country demand analysis.     

Long-run income and price elasticities of demand for Colombian nontraditional exports: a multivariate cointegration framework

A long run income and price elasticities of demand is estimated for Colombian nontraditional exports through a multivariate cointegration analysis. Based on the combination of cointegration and exogeneity concepts and the inclusion of the complete dynamic system, the paper shows the existence of a long-run relationship among nontraditional exports, relative price and foreign demand, and higher long-run elasticities than those provided by the long-run cointegration vector coefficients that are usually reported in the trade literature.     

Cross market predictions for commodity prices

This paper shows that commodity prices can be predicted from cross-market information by establishing long-run cross-market commodity price equilibrium models, which are characterized by a linear relation between prices across different markets. Using data from five representative commodity markets (oil, copper, gold, corn, and cattle) during the period 2005–2018, we demonstrate that oil and industrial metal markets have formed a long-run price equilibrium with other markets across different commodity families. However, agriculture and gold markets do not tend to have long-run price equilibrium relations with other commodity markets. Furthermore, we show that the absence of a price equilibrium is due to the cross-market liquidity interference effect. After we control for the liquidity effect, long-run cross-market commodity price equilibrium relations are reestablished for agriculture and gold markets. These results can aid in demonstrating that liquidity can capture most of the missing information that is not reflected in price dynamics in less liquid markets, such as agriculture and gold markets. Therefore, less liquid commodity price predictions require both prices and liquidity levels from cross-markets, while liquid commodity prices (oil and metal) can be predicted based solely on cross-market prices.