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Purchasing Power Parity and Breaking Trend Functions in the Real Exchange Rate

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  • Jair Ojeda Joya

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Abstract

This paper provides evidence of long run purchasing power parity by performing a recently developed method to test for unit roots in the presence of structural breaks. Data consist of real exchange rate series for 20 countries including developed and developing economies. Structural breaks are detected in 18 countries and real exchange rates are found to be stationary in all countries except Japan. Estimated linear trends are the result of cross-country total factor productivity differentials between tradable and nontradable sectors. Estimated breaks correspond to large and permanent total factor productivity shocks associated with historical events like wars, structural reforms or deep economic recessions. An exercise with total factor productivity data shows that the Balassa-Samuelson effect explains the estimated long run trends in most countries.

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Paper provided by Banco de la Republica de Colombia in its series Borradores de Economia with number 564.

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Handle: RePEc:bdr:borrec:564

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Keywords: Purchasing power parity; unit root test; structural change; Balassa-Samuelson effect; real exchange rate. Classification JEL: C22; F31; F40; N70;

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  1. Alan M. Taylor, 2000. "A Century of Purchasing-Power Parity," NBER Working Papers 8012, National Bureau of Economic Research, Inc.
  2. Taylor, Alan M & Taylor, Mark P, 2004. "The Purchasing Power Parity Debate," CEPR Discussion Papers 4495, C.E.P.R. Discussion Papers.
  3. Lothian, James R. & Taylor, Mark P., 2006. "Real Exchange Rates Over the Past Two Centuries : How Important is the Harrod-Balassa-Samuelson Effect?," The Warwick Economics Research Paper Series (TWERPS) 768, University of Warwick, Department of Economics.
  4. Lopez, Claude & Murray, Christian J & Papell, David H, 2005. "State of the Art Unit Root Tests and Purchasing Power Parity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(2), pages 361-69, April.
  5. Perron, P., 1990. "Further Evidence On Breaking Trend Functions In Macroeconomics Variables," Papers 350, Princeton, Department of Economics - Econometric Research Program.
  6. Graham Elliott & Thomas J. Rothenberg & James H. Stock, 1992. "Efficient Tests for an Autoregressive Unit Root," NBER Technical Working Papers 0130, National Bureau of Economic Research, Inc.
  7. Edwards, Sebastian, 1989. "Exchange Rate Misalignment in Developing Countries," World Bank Research Observer, World Bank Group, vol. 4(1), pages 3-21, January.
  8. Jose De Gregorio & Holger C. Wolf, 1994. "Terms of Trade, Productivity, and the Real Exchange Rate," NBER Working Papers 4807, National Bureau of Economic Research, Inc.
  9. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  10. Perron, P, 1988. "The Great Crash, The Oil Price Shock And The Unit Root Hypothesis," Papers 338, Princeton, Department of Economics - Econometric Research Program.
  11. Vogelsang, T.I. & Perron, P., 1991. "Nonstationary and Level Shifts With An Application To Purchasing Power Parity," Papers 359, Princeton, Department of Economics - Econometric Research Program.
  12. Perron, Pierre & Yabu, Tomoyoshi, 2009. "Testing for Shifts in Trend With an Integrated or Stationary Noise Component," Journal of Business & Economic Statistics, American Statistical Association, vol. 27(3), pages 369-396.
  13. Mohitosh Kejriwal & Pierre Perron, 2006. "Unit Root Tests Allowing for a Break in the Trend Function at an Unknown Time Under Both the Null and Alternative Hypotheses," Boston University - Department of Economics - Working Papers Series WP2006-052, Boston University - Department of Economics.
  14. Serena Ng & Pierre Perron, 1997. "Lag Length Selection and the Construction of Unit Root Tests with Good Size and Power," Boston College Working Papers in Economics 369, Boston College Department of Economics, revised 01 Sep 2000.
  15. Vogelsang, T.J. & Perron, P., 1994. "Additional Tests for a Unit Root Allowing for a Break in the Trend Function at an Unknown Time," Cahiers de recherche 9422, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  16. Papell, David H. & Prodan, Ruxandra, 2006. "Additional Evidence of Long-Run Purchasing Power Parity with Restricted Structural Change," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(5), pages 1329-1349, August.
  17. Josep Lluís Carrion-i-Silvestre & Dukpa Kim & Pierre Perron, 2007. "GLS-based unit root tests with multiple structural breaks both under the null and the alternative hypotheses," Boston University - Department of Economics - Working Papers Series wp2008-019, Boston University - Department of Economics.
  18. Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, vol. 72, pages 584.
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Cited by:
  1. Rafael Puyana, 2010. "El efecto Balassa-Samuelson en Colombia," BORRADORES DE ECONOMIA 007801, BANCO DE LA REPÚBLICA.
  2. Rafael Puyana Martínez-Villaba, . "El efecto Balassa-Samuelson en Colombia," Borradores de Economia 630, Banco de la Republica de Colombia.
  3. Rafael Puyana Martínez-Villalba, 2011. "El efecto Balassa-Samuelson en Colombia," DOCUMENTOS CEDE 007959, UNIVERSIDAD DE LOS ANDES-CEDE.

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