Revisiting long-run purchasing power parity with asymmetric adjustment for G-7 countries

In this study, we applied a threshold cointegration test advanced by Enders and Siklos (2001) to investigate the properties of asymmetric adjustment on long-run purchasing power parity (PPP) in G-7 countries between January 1994 and April 2010. Although there was strong evidence of long-run PPP for these G-7 countries, with the exception of Canada, the adjustment mechanism was asymmetric. These results have important policy implications for G-7 countries.     

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.     

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.     

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 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.     

Food prices and long-run purchasing power parity in Africa

The purchasing power parity (PPP) theory is a cornerstone of exchange rate models in international economics. PPP is very important for two main reasons: first, it can serve as a prediction model for exchange rates, and second, it can serve as a benchmark in judging the level of exchange rate movements. This article utilised the Johansen cointegration technique in examining whether or not there is empirical support for long-run PPP in Africa. Annual data were used for exchange rates and food price indices in 25 countries covering the 1958-97 period. The empirical evidence showed strong support for long-run PPP in Africa, thereby providing wider acceptance for the applicability of PPP in exchange rate and other macroeconomic adjustment policies.     

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.     

Cointegration Tests of Purchasing Power Parity: the Case of the Thai Baht*

This paper will examine the validity of the purchasing power parity (PPP) hypothesis for the Thai baht vis-à-vis the currencies of Thailand's key trading partners under the new exchange rate regime using the cointegration technique. The major conclusions obtained from this empirical analysis may be broadly summarized as follows. First, the empirical evidence, based on the DF and ADF statistics, seems to suggest that the nominal exchange rates and relative prices are well characterized as non-stationary I(1) processes. Second, the cointegration analysis provides no evidence in support of a long-run equilibrium relationship between bilateral nominal exchange rates for the Thai baht vis-à-vis the currencies of Thailand's major trading partners and the corresponding relative price ratios. This implies rejection of PPP for these countries. If this is the case, considerable care should be taken in assessing the long-run implications for the real exchange rate, and thus competitiveness against Thailand's key trading partners, of shocks to the nominal exchange rate.     

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.     

Purchasing Power Parity Between the UK and Germany: The Euro Era

We use the Johansen cointegration approach to assess the empirical validity of the purchasing power parity (PPP) between the UK and Germany since the introduction of the euro. We conduct the empirical analysis in the context of the global financial crisis that began in 2007 and find that it directly affects the cointegration space. We fail to validate the Johansen and Juselius (1992) original hypothesis that nonstationarity of PPP associates with the nonstationarity of interest rate differentials to produce a stationary relation. On the other hand, we do not reject PPP. We find that PPP cointegrates with inflation differentials. We also find, contrary to conventional wisdom, that (i) equilibrium adjustment occurs between the German and UK inflation rates, while weak exogeneity exists for the German and UK interest rates and the PPP condition, and (ii) three common trends associated with the German interest rate the UK interest rate, and the PPP condition “push” the system with the German interest rate and the PPP condition playing dominant roles in affecting inflation in both Germany and the UK. These results cast serious doubt on the presumed independence of the UK monetary policy.     

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.     

Cointegration tests of purchasing power parity

Im et al. (Unpublished working paper, 2008) develop cointegration tests using stationary instrumental variables. Their tests avoid the need to simulate critical values for the cointegration estimations, especially problematic in the presence of a nuisance parameter. Likewise, bootstrapping errors is unnecessary. Using an updated version of the Taylor (Rev Econ Stat 84(1):139–150, 2002) data set, the Im et al. (Unpublished working paper, 2008) approach is applied to two well-known, single equation cointegration methods to test for purchasing power parity. The estimations with instruments provide evidence of purchasing power parity (PPP) for more than half of the countries studied; but the empirical results, hence conclusions regarding PPP sometimes differ with the choice of instrument.     

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     

ESTIMATING EXCHANGE RATE AND BILATERAL TRADE BALANCE RELATIONSHIPS: THE EXPERIENCE OF SUB-SAHARAN AFRICAN COUNTRIES

This paper examines the effects of exchange rate changes on the bilateral trade balance of ten African countries vis‐à‐vis the US using annual data over period 1977‐2002. Both the Johansen and panel cointegration tests find cointegration among the series. The country FMOLS results show that real exchange rate depreciation improves the trade balance in six of ten countries in contrast to Tanzania in which it worsens the trade balance, with no effect found in Ghana, Morocco and Senegal. Foreign real income improves the trade balance in two countries but worsens it in another three. Finally, domestic real income negatively affects the trade balance in four countries but improves it in another three. The three‐panel coefficients are correctly signed and significant at the 1% level.     

USING THRESHOLD COINTEGRATION TO EXAMINE ASYMMETRIC PRICE ADJUSTMENTS BETWEEN ADR'S AND THEIR UNDERLYING SECURITIES - THE CASE OF TAIWAN

Many recent studies have focused on the relationship between American Depository Receipts (ADRs) and their foreign underlying stocks, because of the price interaction and arbitrage opportunities provided by the dual listings. The cointegration and its corresponding error correction model employed in some recent studies assume that the tendency to move towards a long‐run equilibrium is present all the time. However, the presence of costs of adjustments may prevent economic agents from adjusting continuously. As an extension of previous studies, this paper applies the threshold cointegration model that allows for asymmetric adjustment towards a long‐run equilibrium to inspect the linkage between Taiwanese ADRs and their underlying shares. By employing the threshold error correction model, the short‐term adjustments also are examined. We find some evidence of asymmetric adjustments in our data. The tests for asymmetries are also implemented with the maximum likelihood estimation for the complete multivariate threshold cointegration model instead of the univariate model.     

Is the Gulf Cooperation Council an Optimum Currency Area?

This article applies the theory of Generalized Purchasing Power Parity (G‐PPP) to assess the potential for an optimum currency area (OCA) for the Gulf Cooperation Council (GCC) countries over the period 1973–2009. Utilizing a multivariate cointegration procedure that allows for up to two predetermined structural breaks, the results suggest that the GCC countries could form an OCA since macroeconomic conditions are in favor of forming an OCA, i.e., real exchange rates share common trends and the parameter stability test indicates that the G‐PPP relationship has been stable for the period analyzed. Moreover, the results suggest that the withdrawal of Oman and/or United Arab Emirates (UAE) from the union has no impact on forming the union. However, based on other OCA criteria, the results suggest that the OCA may be challenged.     

Real Exchange Rate Forecasting and PPP: This Time the Random Walk Loses

This paper brings four new insights into the Purchasing Power Parity (PPP) debate. First, we show that a half-life PPP (HL) model is able to forecast real exchange rates better than the random walk (RW) model at both short and long-term horizons. Second, we find that this result holds if the speed of adjustment to the sample mean is calibrated at reasonable values rather than estimated. Third, we find that it is preferable to calibrate, rather than to elicit as a prior, the parameter determining the speed of adjustment to PPP. Fourth, for most currencies in our sample, the HL model outperforms the RW also in terms of nominal exchange rate forecasting.     

Financial integration in East Asia: Evidence from panel unit root and panel cointegration tests

The aim of this paper is to investigate the degree of financial integration for selected East Asian countries from 1988 to 2006 using the recently developed panel unit root and panel cointegration techniques. Investment and savings rates are found to be nonstationary and not to be cointegrated in panels. We estimate modified Feldstein–Horioka equations and our results reveal a high degree of financial integration. When we homogenize our data, results show that high-income countries have stronger financial integration than middle-income countries. Finally, we proceed to stability tests in order to test if there is a crisis effect and we find that financial integration is stronger in the post-crisis period.     

人民币汇率与均衡水平偏离的动态非对称调整研究

本文在货币模型框架下，利用Enders（2001）门限协整方法研究人民币名义汇率与其均衡水平（又称基本因素均衡汇率）的偏离，样本区间为1990年1月-2006年12月。通过线性一平稳性检验和半周期分析，我们发现人民币均衡汇率偏离呈现非线性调整，表现为快速和长期持续两种不同的均值回复过程，均衡汇率偏离具有显著的门限效应。结合实际经济运行，本文认为人民币汇率在2005年7月进行升值调整是适时、正确和有效的。