Purchasing Power Parity When Prices Are I(2) |
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| Authors: | William J Crowder |
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| Institution: | Crowder: University of Texas at Arlington, Arlington, TX 76019-0479. Tel: 817-273-3147;Fax: 817-273-3145;Email: . This work has benefited from the comments of Tim Bollerslev, Dennis Hoffman, Michael Melvin, Don Schlagenhauf, the seminar participants at Arizona State University, and an anonymous referee. I alone am responsible for any remaining errors or omissions. |
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| Abstract: | 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. |
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