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Purchasing Power Parity and Interest Parity in the Laboratory,

Purchasing Power Parity and Interest Parity in the Laboratory,

economy with two locations did not hold uniformly; one of those predictions would be that purchasing power parity was true. The third paper in this literature is by Fisher and Kelly (2000). They construct a simple design for analyzing asset prices in non-stationary environments. Their designs consisted of markets for two largely identical dividend-bearing assets. These experiments were based upon the notion that the crux of any theory of international exchange rate determination is really an analysis of cross-asset arbitrage. They found that bubbles arose uniformly in the markets for each individual asset, but that the cross- asset price—the exchange rate—was actually very well behaved. Because the bubbles in the two asset markets were almost perfectly correlated, simple aspects of exchange rate theory did well enough, even in a non-stationary environment.
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The purchasing power parity debate

The purchasing power parity debate

Originally propounded by the 16th-century scholars of the University of Salamanca, the concept of purchasing power parity (PPP) was revived in the interwar period in the context of the debate concerning the appropriate level at which to re-establish international exchange rate parities. Broadly accepted as a long-run equilibrium condition in the post-war period, it first was advocated as a short-run equilibrium by many international economists in the first few years following the breakdown of the Bretton Woods system in the early 1970s and then increasingly came under attack on both theoretical and empirical grounds from the late 1970s to the mid 1990s. Accordingly, over the last three decades, a large literature has built up that examines how much the data deviated from theory, and the fruits of this research have provided a deeper understanding of how well PPP applies in both the short run and the long run. Since the mid 1990s, larger datasets and nonlinear econometric methods, in particular, have improved estimation. As deviations narrowed between real exchange rates and PPP, so did the gap narrow between theory and data, and some degree of confidence in long-run PPP began to emerge again. In this respect, the idea of long-run PPP now enjoys perhaps its strongest support in more than 30 years, a distinct reversion in economic thought.
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Testing Purchasing Power Parity

Testing Purchasing Power Parity

Due to this debate the concept of the purchasing power parity was introduced worldwide and economists started working on the PPP and introduced theories. This paper provides the evidence about the exchange rate value between the two countries Pakistan and India. We explore the determinants of relative PPP between the Pakistan and India. We have selected the exchange rate as a dependent variable and other are independent variable like inflation, interest payment on external debt, gross domestic income, payment on external debts and external balance on goods and services. After that we choose the method to test the PPP analysis through time series regression framework. The test on time series regression line provides the results that there is stationary in the exchange rate of these two countries that have influenced due to the change of independent variable that provide the support about our hypothesis about the PPP. While all selected variables are important and their impact on the PPP but the interest is highly influenced in India on exchange rate and in the case of Pakistan external balance on goods and services has highly impact on exchange rate. Most of the studies about the PPP show the stationary result of real exchange rates. The test about the stationaity is mostly made between currencies by currency. On the basis of the previous studies this paper adopts a genuine time series of regression test which collected all the factors that have their direct influence on the variability of exchange rate. We accepted that there is stationary in the exchange rates and find that PPP is exists as per our sample.
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Cointegration tests of purchasing power parity

Cointegration tests of purchasing power parity

The purpose of this paper is to compare the results from standard, single equation cointegration tests of purchasing power parity with those from an alternative approach recently developed by Im, Lee, and Enders (2006), henceforth ILE. Tests are carried out using the data set on nominal exchange rates and price levels containing 100+ annual observations for twenty countries constructed by Taylor (2002) and updated to 2007. 1 Applying the Elliot, Rothenberg, and Stock (ERS, 1996) unit root test to transformed (demeaned or detrended) real exchange rate data, Taylor finds support for PPP with respect to the US dollar in eighteen of nineteen series. Only data for Japan fail to indicate PPP for either transformed series. When purchasing power parity is tested on real exchange rates with respect to a world market basket, Taylor finds evidence in favor of the hypothesis using demeaned or detrended data in nineteen of the twenty
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Study on the Fluctuation of Purchasing Power Parity

Study on the Fluctuation of Purchasing Power Parity

& middle income economies tend to offer certain subsidy to residents’ consumer goods, which lead to make real price well below market price, thus the increase of the final consumption expenditure proportion may pull down prices across the economy. 3) In upper middle income economies, the contribution degree of China and Malaysia on the variation of purchasing power parity exchange rate is lowest. The reasons for this phenomenon may be China’s investment efficiency is not high 3 . That is to say, the growth of per capita GDP in the data is not bring the country’s produc- tivity compared with other countries. This kind of speculation is matched with the fact that China has presented a low efficiency of investment for a long time. However, Malaysia is facing an income system imbalance and the gap between rich and poor accompanying with the “middle-income trap” in the mid-1990s, that makes GDP growth results not be shared by the national, but the production capacity increases, and that may be a factor leading to limiting the price level relative to other countries rise. In the contribution degree of variation of ex- change rate to the national average price, elastic coefficient of exchange rate in Brazil and Turkey are the largest, the reason is Brazil as one of international commodity exporters hold international commodity pricing power, so it can control the price to a certain degree to keep its profitability remains the same under the background of currency depreciation (the price expressed in local currency remains the same). Based on this consideration, it is not difficult to understand the phenomenon that the variation of the exchange rate has bigger influence on the national average price; Turkey’s elastic coefficient is larger due to its high trade dependence and economic freedom 4 , namely the more close with the world economic and the more flexible price mechanism, the purchas- ing power parity (PPP) is more sensitive to exchange rate
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An Unbiased Appraisal of Purchasing Power Parity

An Unbiased Appraisal of Purchasing Power Parity

We concentrate on the results derived from the regression that allows for the broadest error structure—median-unbiased estimates of Phillips-Perron regres- sions that are robust to the serial correlation and heteroskedasticity commonly found in real exchange rate series. In the post–Bretton Woods period, the majority of countries are found to have finitely persistent shocks to their real effective exchange rates, which is consistent with the reversion of exchange rate deviations from PPP. Averaging across all countries, the point estimate of the half-life of par- ity deviations is about five years, which is consistent with (but at the upper end of) Rogoff’s (1996) consensus estimate of the half-life of deviations from purchasing power parity. In summary, while median-unbiased methods increase the estimated half-life of deviations from PPP in comparison with downwardly biased least- squares-based methods, allowing for heteroskedasticity reduces the bias-corrected estimated half-life of parity deviations.
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Nonlinear Trend and Purchasing Power Parity

Nonlinear Trend and Purchasing Power Parity

However, whether PPP is valid in the short-run or over the long-run is a problem. Indeed, much of economists’ faith in PPP derives from a belief that over most of the past century, price level movements have been dominated by monetary factors. If price indices movements are dominated by monetary shocks, and if money is neutral in the long run then even if PPP is not valid in the short-run it will valid over the long run. For example, early monetary models of the exchange rate assume continuous purchasing power parity [see survey in Taylor(1995)]. Although sticky-price exchange rate models of the kind originally developed by Dornbusch(1976) allow the exchange rate to deviate from PPP in the short-run, it is retained as long-run equilibrium condition.
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Purchasing Power Parity and the Chinese Yuan

Purchasing Power Parity and the Chinese Yuan

A vast literature has developed applying various unit root tests to real exchange rates to test the PPP hypothesis. Sarno and Taylor (2002) and Sarno (2005) provide overviews of the empirical literature in testing purchasing power parity. The general consensus is that for the currencies of major industrialized nations, PPP is a valid long-run international parity condition and that mean reversion displays significant non-linearities, with small deviations having a longer half-life than larger deviations. Econometric studies tend to find that deviations from PPP are highly volatile and that the volatility of relative prices is
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Cointegration tests of purchasing power parity

Cointegration tests of purchasing power parity

The purpose of this paper is to compare the results from standard, single equation cointegration tests of purchasing power parity with those from an alternative approach recently developed by Im, Lee, and Enders (2006), henceforth ILE. Tests are carried out using the data set on nominal exchange rates and price levels containing 100+ annual observations for twenty countries constructed by Taylor (2002), updated to 2007. 1 Applying the Elliot, Rothenberg, and Stock (ERS, 1996) unit root test to transformed (demeaned or detrended) real exchange rate data, Taylor finds support for PPP with respect to the US dollar in eighteen of nineteen series. Only data for Japan fail to indicate PPP for either transformed series. When purchasing power parity is tested on real exchange rates with respect to a world market basket, Taylor finds evidence in favor of the hypothesis using demeaned or detrended data in nineteen of the twenty
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Nonlinear Trend and Purchasing Power Parity

Nonlinear Trend and Purchasing Power Parity

By Yinghao LUO a† Abstract. After the collapse of the Bretton Woods system, the evidence on the purchasing power parity (PPP) in the long run is still a matter of debate. The difficulties of the problem are the possible nonstationarity of relative price indices and nominal exchange rates. The traditional ways to deal with nonstationarity such as unit root model and cointegration have some problems. In this paper, to deal with nonstationarity, we apply the Hodrick-Prescott (HP) trend-cycle filter in real business cycle literature ( Hodrick & Prescott, 1981 ) which can give a nonlinear smooth-trend, and we find that after the 1970s float, the monthly HP trends of US dollar/UK sterling and Deutsche marks/US dollar have certain relevance with their corresponding HP trends of relative consumer price indices. This result indicates that there is no strong evidence to directly deny that the PPP is valid in the long run. In this sense, it is not reliable to directly deny the belief of monetary neutrality!
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Pairwise tests of purchasing power parity

Pairwise tests of purchasing power parity

“empirical work could find only the flimsiest evidence in support of purchasing power parity”. 3 However, the evidence for PPP is stronger using century-long spans of data. This is partly because the power of the test depends on the span, the number of years, not the number of observations and partly because long spans tend to show periods of high variances, e.g. resulting from wars or political crises. Cross-section regressions of the percentage change in the exchange rate against inflation differentials also tend to yield coefficients very close to unity, again partly because of the higher cross-sectional variation as compared to the time variation of real exchange rates. The failure to reject λ ijt = 0 in the case of time-series with a short-span can be attributed to the low power of unit root tests applied to the individual series and one response has been to try to increase power by using panel unit root tests.
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Convergence of absolute purchasing power parity

Convergence of absolute purchasing power parity

Zhang, Z. & Zou, X. (2014). Different measures in testing absolute purchasing power parity. Applied Economics Letters, 21, 828–831. Appendix Tables The detailed results of the unit root tests in the whole period for each of the 40 RERs in Section 3.1 are listed in the Appendix Table 1, which shows that all of the variables are I(0) at one usual level (the 1%, 5%, or 10% level). The unit root test results for the sub-periods for each of the 35 RERs in Section 3.2 are listed in the Appendix Table 2, which also shows that all of the variables are I(0) at one usual level. The unit root test is implemented by using the software EViews 7.
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Purchasing power parity in Mexico: a historical note

Purchasing power parity in Mexico: a historical note

One approach to testing for purchasing power parity is to test r t for the presence of a (linear) unit root. The absence of a unit root is evidence of mean reversion, usually regarded as evidence of reversion to its PPP value. 7 A series of linear unit root tests are applied to the full sample and the January 1930-December 1951 and January 1952-December 1960 subsamples. The subsamples are selected to isolate the period of import substitution, a period in which PPP is less likely to hold due to diminished trade. In most cases, the linear tests fail to find evidence of stationarity. 8 There are no indications of seasonality in the data; the mean real exchange rate is virtually the same each month despite substantial variation in r t over
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Purchasing power parity and free trade area

Purchasing power parity and free trade area

falling of transportation costs because the average cost of transportation falls as the volume of trade increases. Therefore, trade agreements could contribute to price convergence and foster economic integration. Since many regional trade agreements appeared to facilitate trade and spur economic growth, this paper aims to examine whether or not the purchasing power parity (PPP) hypothesis for regional agreements has been satisfied.

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Purchasing power parity: A nonlinear multivariate perspective

Purchasing power parity: A nonlinear multivariate perspective

Abstract The goal of this paper is to disentangle the respective contributions of the nominal exchange rate and the price differential to the adjustment towards the Purchasing Power Parity relation. To this end, we estimate a multivariate threshold vector equilibrium correction model, whose dynamics is consistent with the PPP in presence of trading costs. European data support the relevance of this model for Belgium, France and Italy, but this is not the case for the G7 data against the US Dollar. Furthermore, the adjustment in European countries seems to have been achieved only through nominal exchange rate changes.
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Analysis of Purchasing power parity with data for Macedonia

Analysis of Purchasing power parity with data for Macedonia

Key words : The theory of purchasing power parity (PPP) constitutes one of the basic elements of exchange rate determination.In the case of absolute PPP the exchange rate equals the relative price levels between the countries, whereas in the case of relative PPP the exchange rate

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The micro-macro disconnect of purchasing power parity

The micro-macro disconnect of purchasing power parity

The persistence of aggregate real exchange rates is a prominent puzzle, particularly since adjustment of international relative prices in microeconomic data is much faster. This paper finds that adjustment to the law of one price in disaggregated data is not just a faster version of the adjustment to purchasing power parity in the aggregate data; while aggregate real exchange rate adjustment works primarily through the foreign exchange market, adjustment in disaggregated data is a qualitatively distinct process, working through adjustment in local-currency goods prices. These distinct adjustment dynamics appear to arise from distinct classes of shocks generating macro and micro price deviations. A vector error correction model nesting aggregate and disaggregated relative prices permits identification of distinct macroeconomic and good-specific shocks. When half-lives are estimated conditional on shocks, the macro-micro disconnect puzzle disappears: microeconomic relative prices adjust to macro shocks just as slowly as do aggregate real exchange rates. These results provide evidence against theories of real exchange rate behavior based on sticky prices and on
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The Micro-Macro Disconnect of Purchasing Power Parity

The Micro-Macro Disconnect of Purchasing Power Parity

ABSTRACT This paper reconciles the persistence of aggregate real exchange rates with the faster adjustment of international relative prices in microeconomic data. Panel estimation of an error correction model using a micro data set uncovers new stylized facts regarding this puzzle. First, adjustment to purchasing power parity deviations in aggregated data is not just a slower version of adjustment to the law of one price in microeconomic data, as arbitrage occurs in different markets, in response to distinct macroeconomic and microeconomic shocks. Second, when half-lives are estimated conditional on macro shocks, micro relative prices exhibit just as much persistence as aggregate real exchange rates. These results challenge theories of real exchange rate persistence based on sticky prices and on heterogeneity across goods, and support an explanation based on the presence of distinct macro and microeconomic shocks.
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Purchasing Power Parity Tests in Cointegrated Panels

Purchasing Power Parity Tests in Cointegrated Panels

* Indiana University. Some of the Ž ndings in this paper Ž rst appeared in a working paper entitled “Panel Fully ModiŽ ed OLS for Heterogeneou s Cointegrated Panels and the Case of Purchasing Power Parity,” Indiana University (June 1996). The econometric theory and Monte Carlo portion of the working paper are available in Advances in Econometrics, vol. 15. I thank especially Bob Cumby, Pravin Trivedi, three anonymous referees, and James Stock as editor for helpful comments and suggestion s on various earlier versions. This study has also beneŽ tted from presentation at the North American Econometric Society Summer Meetings (June 1996), the Midwest Internationa l Economics Meetings (April 1996), and workshop seminars at Rice University-Universit y of Houston, Southern Methodist University, The Federal Reserve Bank of Kansas City, U.C. Santa Cruz, and Washington University. A computer program that implements the between-dimensio n DOLS procedure introduced in this paper is available upon request from the author.
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Purchasing power parity in the Colombian exchange rate

Purchasing power parity in the Colombian exchange rate

Keywords: Purchasing power parity; Real exchange rate; Unitary root; Cointegration. Resumen Objetivo: determinar el cumplimiento de la teoría de la Paridad del Poder Adquisitivo (PPA) en Colombia usando como patrón el tipo de cambio con el dólar estadounidense. Metodología: para comprobar si se cumple la PPA en Colombia, se utilizaron datos mensuales y trimestrales que van desde enero de 1959 a diciembre de 2015. Para ello, se modelizó el comportamiento a largo plazo del tipo de cambio real, contrastando la presencia de raíces unitarias y cambios estructurales; además, se usó un modelo bivariado de cointegración. Resultados: se encontró que, para el caso de Colombia, no se cumplió la teoría de PPA, pues el peso y el dólar no están cointegrados.
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