Nonlinear Modelling of Purchasing Power Parity in Indonesia
AbstractThis paper models the dynamics of the adjustment process of Indonesian purchasing power parity (PPP) relative to US, Japan and Singapore by employing a nonlinear framework, which is recently shown to be appropriate in the presence of transaction costs associated with international trade. Using monthly observations from January 1979 to June 2003 (post-Bretton Woods period), covering the managed- and free-floating regimes in Indonesia, the real exchange rates were tested for their mean-reverting properties. A large number of studies found the real exchange series to be mean-averting and persistent, creating PPP puzzles. Using the linear framework many attempted to resolve these puzzles unsuccesfully. Motivated by the success of recent studies on PPP, applying a non-linear ESTAR to model the adjustment process, we tested for mean-reverting properties of all three real exchange rates for small and large deviations from the long-run equilibrium. We find that the small deviations are non-stationary, persistent and they can be explosive, while the large deviations are stationary with the adjustment process being very fast, making the overall adjustment process mean-reverting
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Date of creation: 11 Aug 2004
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Purchasing Power Parity; ESTAR model; Mean-reversion;
Find related papers by JEL classification:
- C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models &bull Diffusion Processes
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
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