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Purchasing Power Parity: the Choice of Price Index

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  • Maria Cristina T. Terra
  • Ana Lucia Vahia de Abreu

Abstract

Looking closely at the PPP argument, it states that the currencies purchasing power should not change when comparing the same basket goods across countries, and these goods should all be tradable. Hence, if PPP is valid at all, it should be captured by the relative price indices that best fits these two features. We ran a horse race among six different price indices available from the IMF database to see which one would yield higher PPP evidence, and, therefore, better fit the two features. We used RER proxies measured as the ratio of export unit values, wholesale prices, value added deflators, unit labor costs, normalized unit labor costs and consumer prices, for a sample of 16 industrial countries, with quarterly data from 1975 to 2002. PPP was tested using both the ADF and the DF-GLS unit root test of the RER series. The RER measured as WPI ratios was the one for which PPP evidence was found for the larger number of countries: six out of sixteen. The worst measure of all was the RER based on the ratio of foreign CPIs and domestic WPI. No evidence of PPP at all was found for this measure

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 Latin American Meetings with number 247.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:latm04:247

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Keywords: Real exchange rate; price indices; purchasing power parity;

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References

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  1. 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.
  2. Ken Froot & Kenneth Rogoff, . "Perspectives on PPP and Long-Run Real Exchange Rates," Working Paper 32027, Harvard University OpenScholar.
  3. Rudiger Dornbusch, 1985. "Purchasing Power Parity," NBER Working Papers 1591, National Bureau of Economic Research, Inc.
  4. Chinn, Menzie D., 2000. "Before the fall: were East Asian currencies overvalued?," Emerging Markets Review, Elsevier, vol. 1(2), pages 101-126, September.
  5. Cheung, Yin-Wong & Lai, Kon S., 1998. "Parity reversion in real exchange rates during the post-Bretton Woods period," Journal of International Money and Finance, Elsevier, vol. 17(4), pages 597-614, August.
  6. Lucio Sarno & Mark P. Taylor, 2002. "Purchasing Power Parity and the Real Exchange Rate," IMF Staff Papers, Palgrave Macmillan, vol. 49(1), pages 5.
  7. Takatoshi Ito & Tamim Bayoumi & Peter Isard & Steven A. Symansky, 1996. "Exchange Rate Movements and Their Impact on Trade and Investment in the APEC Region," IMF Occasional Papers 145, International Monetary Fund.
  8. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  9. Alan M. Taylor, 2002. "A Century Of Purchasing-Power Parity," The Review of Economics and Statistics, MIT Press, vol. 84(1), pages 139-150, February.
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Citations

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Cited by:
  1. Bonomo, Marco Antônio Cesar & Terra, Maria Cristina T., 2005. "Special Interests and Political Business Cycles," Economics Working Papers (Ensaios Economicos da EPGE) 597, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  2. Flôres Junior, Renato Galvão & Watanuki, Masakazu, 2006. "Integration Options for Mercosul - An Investigation Using the AMIDA Model," Economics Working Papers (Ensaios Economicos da EPGE) 610, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  3. Araújo, Fabio & Issler, João Victor & Fernandes, Marcelo, 2005. "Estimating the Stochastic Discount Factor without a Utility Function," Economics Working Papers (Ensaios Economicos da EPGE) 583, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  4. Barbosa, Fernando de Holanda, 2005. "The Contagion Effect of Public Debt on Monetary Policy: The Brazilian Experience," Economics Working Papers (Ensaios Economicos da EPGE) 591, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  5. Cysne, Rubens Penha, 2006. "Income Inequality in a Job-Search Model With Heterogeneous Discount Factors (Revised Version, Forthcoming 2006, Revista Economia)," Economics Working Papers (Ensaios Economicos da EPGE) 611, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  6. Cysne, Rubens Penha, 2006. "An Intra-Household Approach to the Welfare Costs of Inflation (Revised Version, Forthcoming 2006, Estudos Econômicos)," Economics Working Papers (Ensaios Economicos da EPGE) 612, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).

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