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Is the Relationship Between Prices and Exchange Rates Homogeneous?

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  • Stephen Hall

    ()

  • George Hondroyiannis
  • Amangeldi Kenjegaliev
  • P.A.V.B. Swamy
  • George S. Tavlas

Abstract

Empirical tests of purchasing power parity (PPP) are implicitly based on the conditions of symmetry and proportionality of the price coefficients. We investigate a separate condition, which we term homogeneity. Specifically, while there may be factors that drive a wedge between prices and exchange rates, when these factors are held constant we would expect a change in exchange rates to be associated with a proportional, or homogeneous, change in prices. To test for the existence of homogeneity in prices, we conduct two experiments. First, we apply a time-varying-coefficient procedure to nine euro-area countries as well as the euro area as a whole during the (monthly) sample period, 1999: M1 to 2011:M3. Second we apply the same procedure to the same group of countries, plus Canada, Japan and Mexico, over the longer period, 1957:M4 to 2011:M3. We find that averages of the price coefficients, corrected for specification biases, are uniformly homogeneous in the long run, providing strong support for PPP.

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Bibliographic Info

Paper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 13/13.

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Date of creation: Jul 2013
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Handle: RePEc:lec:leecon:13/13

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Keywords: Purchasing power parity; symmetry; proportionality; homogeneity; generalized cointegration; time-varying coefficients.;

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References

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  1. Alan M. Taylor & Mark P. Taylor, 2004. "The Purchasing Power Parity Debate," NBER Working Papers 10607, National Bureau of Economic Research, Inc.
  2. Shiu-Sheng Chen & Charles Engel, 2005. "Does 'Aggregation Bias' Explain The Ppp Puzzle?," Pacific Economic Review, Wiley Blackwell, vol. 10(1), pages 49-72, 02.
  3. Stephen Hall & Amangeldi Kenjegaliev & P.A.V.B. Swamy & George S. Tavlas, 2013. "Measuring Currency Pressures: The Cases of the Japanese Yen, the Chinese Yuan, and the U.K. Pound," Discussion Papers in Economics 13/10, Department of Economics, University of Leicester.
  4. Cerrato, Mario & Sarantis, Nicholas, 2008. "Symmetry, proportionality and the purchasing power parity: Evidence from panel cointegration tests," International Review of Economics & Finance, Elsevier, vol. 17(1), pages 56-65.
  5. Granger, C. W. J. & Newbold, P., 1974. "Spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 2(2), pages 111-120, July.
  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. R Macdonald, . "Long Run Purchasing Power Parity: Is It For Real?," Dundee Discussion Papers in Economics 029, Economic Studies, University of Dundee.
  8. P. Swamy & George Tavlas, 2007. "The New Keynesian Phillips Curve and Inflation Expectations: Re-Specification and Interpretation," Economic Theory, Springer, vol. 31(2), pages 293-306, May.
  9. P. Swamy & George Tavlas, 2005. "Theoretical conditions under which monetary policies are effective and practical obstacles to their verification," Economic Theory, Springer, vol. 25(4), pages 999-1005, 06.
  10. Imad A. Moosa, 1994. "Testing Proportionality, Symmetry and Exclusiveness in Long-run PPP," Journal of Economic Studies, Emerald Group Publishing, vol. 21(3), pages 3-21, September.
  11. Hall Stephen G. & Kenjegaliev Amangeldi & Swamy P. A. V. B. & Tavlas George S., 2013. "The forward rate premium puzzle: a case of misspecification?," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 17(3), pages 265-279, May.
  12. Swamy P. A. V. B. & Tavlas George S & Hall Stephen G. F. & Hondroyiannis George, 2010. "Estimation of Parameters in the Presence of Model Misspecification and Measurement Error," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 14(3), pages 1-35, May.
  13. Stephen Hall & P. A. V. B. Swamy & George S. Tavlas, 2011. "Generalized Cointegration: A New Concept with an Application to Health Expenditure and Health Outcomes," Discussion Papers in Economics 11/22, Department of Economics, University of Leicester.
  14. Lothian, James R & Taylor, Mark P, 1996. "Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 488-509, June.
  15. Hali J. Edison & Joseph E. Gagnon & William R. Melick, 1994. "Understanding the empirical literature on purchasing power parity: the post-Bretton Woods era," International Finance Discussion Papers 465, Board of Governors of the Federal Reserve System (U.S.).
  16. Granger Clive W.J., 2008. "Non-Linear Models: Where Do We Go Next - Time Varying Parameter Models?," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 12(3), pages 1-11, September.
  17. Lothian, James R. & Taylor, Mark P., 2000. "Purchasing power parity over two centuries: strengthening the case for real exchange rate stability: A reply to Cuddington and Liang," Journal of International Money and Finance, Elsevier, vol. 19(5), pages 759-764, October.
  18. Cheung, Yin-Wong & Lai, Kon S., 1993. "Long-run purchasing power parity during the recent float," Journal of International Economics, Elsevier, vol. 34(1-2), pages 181-192, February.
  19. Li, Kai, 1999. "Testing Symmetry and Proportionality in PPP: A Panel-Data Approach," Journal of Business & Economic Statistics, American Statistical Association, vol. 17(4), pages 409-18, October.
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