Do Real Exchange Rates Follow a Nonlinear Mean Reverting Process in Developing Countries?

In an effort to fight relatively high inflation, many developing countries try to manage their nominal exchange rates through official intervention. In addition, developing countries tend to have high transportation costs, tariffs, and nontariff barriers. These factors are among the sources of generating nonlinearity in real exchange rates and hence some nonlinear adjustment toward purchasing power parity (PPP) in developing countries. In this paper, we employ monthly real effective exchange rate (REER) data of 88 developing countries and test the null of nonstationarity versus an alternative of linear stationarity by the means of a conventional unit root test and compare the results with those obtained from a new test in which the null is the same but the alternative hypothesis is nonlinear stationarity. The latter test supports the PPP theory in more developing countries compared with the former test, suggesting that nonlinear adjustment toward PPP in developing countries is an important phenomenon. Reported country characterizations indicate that reversion in REER occurs more often for high-inflation countries and for countries with high flexibility in their exchange rates.     

DO AFRICAN COUNTRIES MOVE ASYMMETRICALLY TOWARDS PURCHASING POWER PARITY?

This paper investigates the possibility that the adjustment towards long‐run relative purchasing power parity (PPP) is dependent upon the nature of deviations from PPP that are experienced. While existing studies involving developed and less developed countries often find against PPP having employed linear tests of non‐stationarity or non‐cointegration, we employ a new cointegration test, recently advocated by Enders and Siklos and Enders and Dibooglu, that tests for an asymmetric adjustment towards parity with respect to positive and negative deviations of the real exchange rate from its equilibrium value. Using a sample often African economies with data taken from the post‐Bretton Woods floating exchange rate era, long‐run PPP holds in eight of these cases if an explicit distinction is made between positive and negative deviations. Across the sample, we find variation in the type of asymmetry experienced and the roles played by price and nominal exchange rate adjustment.     

Assessing convergence to purchasing power parity: A panel study for ten OECD countries

Assessing Convergence to Purchasing Power Parity: A Panel Study for 10 OECD Countries. — The paper analyzes whether post-Bretton Woods real exchange rates of ten OECD countries are nonstationary so that long-run purchasing power parity (PPP) can be considered to hold. A test procedure is proposed which treats the various real exchange rates as a panel but still allows to assess the rate of convergence to PPP for each pair of currencies separately. It is shown that long-run (tradables-) PPP holds between all countries analyzed. Rates of convergence to PPP, however, are found to be quite different across countries. For most of the OECD countries convergence takes place faster than previously indicated.     

Testing PPP for the South African Rand/US Dollar Real Exchange Rate at Different Data Frequencies

This paper tests the PPP hypothesis for the South African rand/US dollar real exchange rate using a fractional integration framework. The results suggest that the real exchange rate of the South African rand with respect to the US dollar is a highly dependent variable with an order of integration very close to 1. This finding is not affected by the data frequency considered (daily, weekly or monthly). Also, there appears to be a single break in December 2001 (possibly corresponding to a change in the monetary policy framework), with the unit root null being rejected in favour of d > 1 for the periods before the break, but not afterwards. Thus, our results strongly reject the PPP hypothesis for the South African rand/US dollar rate across data frequencies, since shocks are found to affect the exchange rate forever.     

PPP: <Emphasis Type="Italic">Delusion</Emphasis> or <Emphasis Type="Italic">Reality</Emphasis>? Evidence from a Nonlinear Analysis

In this paper we analyze the validity of the purchasing power parity (PPP) in a nonlinear framework using data for 18 bilateral US dollar exchange rates. Following Enders and Ludlow (2002), we use unit root and cointegration tests that do not assume a specific nonlinear adjustment. We find evidence of non-linear mean reversion in deviations from the PPP equilibrium in 11 out of 18 currencies. Additionally, to disentangle the respective contribution of exchange rate and prices to the adjustment toward the long run equilibrium, we estimate a Vector Error Correction Model. According to our empirical analysis, there exists a nonlinear mechanism to correct for deviation from the PPP equilibrium that comes mainly from the exchange rates. This is consistent with theoretical arguments on international goods markets under transaction costs as well as with an emerging strand of empirical literature. These results highlight the importance of neglecting the possibility of nonlinearity in the debate about the PPP and provide empirical evidence that supports the scenario of the PPP hypothesis as a reality.     

PURCHASING POWER PARITY IN AFRICAN COUNTRIES: EVIDENCE FROM PANEL SURADF TEST

This study reexamines the validity of long-run purchasing power parity (PPP) hypothesis using a battery of panel unit root tests for 11 developing countries in Africa over the period 1980-2007. Based on the conventional panel unit root tests, we found evidence that the monthly real exchange rates in these countries were mean reverting. By contrast, the series-specific unit root test proposed by Breuer et al. (SURADF) reveals that only six of the 11 RERs series were stationary using the US dollar as reference currency. Additionally, our results reveal that there is stronger evidence of the parity condition with the Rand-based rates than in the other currency-based rates like the US dollar or Euro. We conclude that PPP holds in some, but not all, of the African countries according to the SURADF tests.     

Purchasing Power Parity before and after the Adoption of the Euro

This paper examines the purchasing power parity (PPP) hypothesis for the post–Bretton Woods era including the period after the introduction of the euro. The study applies a new nonlinear unit root test to the bilateral real exchange rates (RERs) of both European and other industrial countries with the French franc and German mark (and the euro after 1998), as well as the US dollar as numeraire currencies. The results of the study provide stronger support for PPP than any earlier studies of bilateral PPP for industrial countries and suggest that (1) PPP tends to hold well within the European Union (EU) even before the adoption of the euro, (2) the evidence for PPP becomes more significant for both EU and non-EU countries when the sample period is extended to the euro era, and (3) convergence toward PPP between the EU countries, especially between the euro-area countries, tends to be nonlinear, while it is likely to be linear for the non-EU industrial countries. JEL no. F31, F33, G15, C22     

Fulfilment of purchasing power parity conditions in Africa: the differential role of CFA and non-CFA membership

The paper reports empirical evidence on the fulfilment or otherwiseof purchasing power parity (PPP) conditions in African countries,based on the popular augmented Dickey-Fuller test methodologythat is used to identify whether the nominal exchange rate andprice levels are co-integrated. The empirical analysis is basedon quarterly data for the 1980(I)-1991(IV) period for 35 Africancountries and our finding is that the PPP conditions are metin 17 countries that are almost exclusively non-CFA zone membersbut are not met in the remaining 18 countries comprising ninenon-CFA and nine CFA zone members. Given this lopsidedness inthe distribution of countries where the conditions are met ornot met between the two zones, it is inferred that certain macroeconomicfeatures common to the CFA zone members but which are generallyless pronounced in other countries might have been responsiblefor this finding. A number of such features relating to theextent of monetary growth, inflation rates, rate of depreciationof real and nominal exchange rates, domestic price variability,nominal exchange rate variability and the type of exchange ratesystem being operated were related to the tendency for PPP tobe fulfilled across countries. But, while the direction of theirobserved effects are generally as expected, the effects do notexhibit statistical significance.     

PURCHASING POWER PARITY IN AFRICAN COUNTRIES: FURTHER EVIDENCE FROM FOURIER UNIT ROOT TESTS BASED ON LINEAR AND NONLINEAR MODELS

This paper examines the validity of purchasing power parity hypothesis for 33 African countries using recently developed Fourier unit root tests by Christopoulos and León‐Ledesma that account for the existence of multiple breaks in the real exchange rates. The results support the evidence of the PPP in 20 countries, showing that most of the real exchange rates in the selected countries are characterised by linear or nonlinear stationary around multiple temporary mean changes.     

Generalized purchasing power parity and the case of the European Union as a successful currency area

This article uses multicountry purchasing power parity (PPP) tests to study the success of the European monetary system (EMS) in creating a successful currency area for a stable European monetary union. If the EMS has sufficiently integrated the fundamentals within the European Union, then real exchange rates between member countries will share a common stationary trend when denominated by a common outside currency. Previous research using two-country PPP tests have been inadequate in explaining the nonstationary nature of real exchange rates between the EMS countries and nonmember countries. The use of generalized PPP tests can show that even though individual exchange rates within the EMS may appear to be nonstationary with respect to outside countries, some of them will combine to form a currency union with a stable stationary trend.     

Nonstationarity of Real Exchange Rates in the G7 Countries: Are They Cointegrated with Real Variables?

Using monthly data for the G7 countries in the post-Bretton Woods floating rate period, this paper demonstrates that almost all bilateral real exchange rates have unit roots and, hence, are nonstationary. Consequently, it rejects simple PPP as a long-run relationship. The paper also shows that many of these real exchange rates are cointegrated with other real economic variables such as relative labor productivity, terms-of-trade ratios, real trade balance ratios, and long-term real interest rate differentials. In particular, relative labor productivity is statistically significant with the correct sign for more than half of the country pairs for which cointegration is confirmed. This finding lends support to the Balassa–Samuelson productivity-bias hypothesis. These results imply that nonstationarity of real exchange rates and the consequent rejection of simple PPP can be consistent with the notion that real exchange rates revert to an equilibrium in the long run without deviating arbitrarily far from this equilibrium position.J. Japan. Int. Econ.,December 1997, pp. 523–547. Institute of Social Science, University of Tokyo, 7-3-1 Hongo, Bunkyo-ku, Tokyo 113, Japan, and Faculty of Business and Commerce, Meiji University, 1-1 Kanda, Surugadai, Chiyada-ku, Tokyo 101, Japan.     

PURCHASING POWER PARITY WITH RANK TESTS FOR NONLINEAR COINTEGRATION IN AFRICAN COUNTRIES

This study applies nonlinear cointegration to assess exchange rates with the corresponding relative prices and aggregate price levels for 20 African countries. We find that a nonparametric rank test has higher power than parametric testing procedures; a true data‐generating process of exchange rate is in fact a stationary nonlinear process. We examine the validity of purchasing power parity (PPP) from the nonparametric nonlinear point of view and provide robust evidence that clearly indicates PPP holds true for these countries. Hence, the long‐run African countries exchange rate adjustments are in equilibrium with the relevant fundamentals as suggested by the PPP hypothesis in a nonlinear way.     

Evidence of long-run purchasing power parity: analysis of real asian exchange rates in terms of the Japanese yen

In this paper we find strong new evidence in favour of the long-run purchasing power parity (PPP) hypothesis in the bilateral real exchange rates between the Japanese yen and the currencies of the most important southeast Asian economies only when the presence of several possible structural breaks of the series is taken into account. Such evidence for PPP is weaker for these southeast Asian exchange rates with the US dollar, the German mark and the Australian dollar.     

Real exchange rate misalignment and business cycle fluctuations in the Asia-Pacific

Real exchange rate (RER) misalignment, which is the deviation between the actual real exchange rate from its equilibrium, occurs frequently among developing countries. Studies have shown that RER misalignment may have negative economic implications, such as a decline in economic growth, exports, and export diversification and an increased risk of currency crises and political instability. Using quarterly data for 22 sample countries from 1990 to 2018, this paper investigates the impact of RER misalignment on business cycles in the Asia-Pacific by employing a panel vector autoregression involving consumer price index (CPI) inflation, output gap, short-term interest rates, and RER misalignment. We find that RER overvaluation may reduce CPI inflation and short-term interest rates. We also find that the Asia-Pacific region is highly heterogeneous in that the output gaps of some countries, particularly from the Southeast Asian region, are more susceptible to RER misalignment shocks.     

Is reversion to PPP in euro exchange rates non-linear?

The paper tests for nonlinearities in the adjustment of the euro exchange rate towards purchasing power parity (PPP). It presents new survey based evidence consistent with non-linear patterns in euro exchange rate dynamics. Moreover, based on an exponential smooth transition autoregressive (ESTAR-) model, it finds strong evidence that the speed of mean reversion in euro exchange rates increases non-linearly with the magnitude of the PPP deviation. Accordingly, while the euro real exchange rate can be well approximated by a random walk if PPP deviations are small, in periods of significant deviations, gravitational forces are set to take root and bring the exchange rate back towards its long-term trend. Deviations from the PPP equilibrium for the euro-dollar rate need to be stronger in order to reach the same adjustment intensity as for other rates.

Purchasing Power Parity in High-Inflation Countries: A Cointegration Analysis of Integrated Variables with Trend Breaks

This paper examines the long-run validity of purchasing power parity (PPP) for four high-inflation countries. The method of Zivot and Andrews (1992) is employed to detect the time-series behavior of the exchange rates and consumer price indices of these countries. We find that these variables are integrated with some trend breaks. We then utilize these data to test PPP using Johansen's (1988) multivariate cointegration technique. The cointegration tests are conducted with the correction of the finite sample bias and the adjustment for trend breaks. The results are consistent with the argument that, during the recent floating exchange-rate period, PPP holds well, at least in a weak form, in high-inflation countries where the general price level movement overshadows the factors causing deviations from PPP.     

Mean Reversion of Real Exchange Rates in High-Inflation Countries

We test for mean reversion in real exchange rates using data from five countries, four of which have experienced episodes of high inflation. Using monthly data for Argentina, Brazil, Chile, Colombia, and Israel, we find that a stochastic unit root model is typically appropriate (Brazil is the exception). Kalman filter estimates of the stochastic unit roots show sharp deviations from unity associated with high inflation episodes. This suggests that stochastic unit root models are a more appropriate way to model mean reversion in real exchange rates for high inflation countries than models with fixed rates of mean reversion.     

Nonlinear Purchasing Power Parity under the Gold Standard

Hegwood and Papell (2002) conclude on the basis of analysis in a linear framework that long-run purchasing power parity (PPP) does not hold for 16 real exchange rate series, which were analyzed in Diebold. I lusted, and Rush (1991) for the period 1792-1913 under the Gold Standard. Rather, PPP deviations are mean-reverting to a changing equilibrium—a quasi PPP (QPPP) theory. We analyze the real exchange rate adjustment mechanism for their data set assuming a nonlinear adjustment process allowing for both a constant and a mean shifting equilibrium. Our results confirm that real exchange rates at that time were stationary, symmetric, nonlinear processes that revert to a nonconstant equilibrium rate. Speeds of adjustment were much quicker when breaks were allowed.     

The trend behavior of real exchange rates: Evidence from OECD countries

The Trend Behavior of Real Exchange Rates: Evidence from OECD Countries. — This paper examines the validity of purchasing power parity (PPP) under the current float using real effective exchange rates of eleven OECD countries. The author employs a test which allows for a one-time change in the intercept and/or in the slope of the trend function. The timing of the structural break is treated as unknown and is endogenously searched from the data. It is found that for a vast majority of countries, the real exchange rate can be characterized as a stationary process with a broken trend. The paper provides support for PPP in the long run.     

Purchasing Power Parity in South East Asian Countries Economies: A Cointegration Approach

This paper presents findings from a study of the long-run purchasing power parity (PPP) conditions in five Asian economies. The cointegration tests using exchange rates and price indices from end-of-quarter observations over the last twenty years reject the PPP proposition for all countries. The absolute version of the PPP hypothesis is tested next by using lower frequency, that is, semi-annual and annual, data. In general these tests also failed to support the long-run PPP hypothesis. Further analysis using the Johansen-Juselius (1990) multivariate approach also failed to support the hypothesis.