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Purchasing Power Parity between the UK and the Euro Area

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  • Giorgio Canarella

    ()
    (Department of Finance, University of Nevada, Las Vegas)

  • Stephen M. Miller

    ()
    (Department of Economics, University of Nevada, Las Vegas)

  • Stephen K. Pollard

    (Department of Economics, California State University, Los Angeles)

Abstract

We use the Johansen cointegration approach to assess the empirical validity of the purchasing power parity (PPP) between the UK and the Euro Area, which we represent by Germany, the largest of its members. We conduct the empirical analysis in the context of the global financial crisis that began in 2007 and find that it directly affects the cointegration space. We fail to validate the Johansen and Juselius (1992) original hypothesis that nonstationarity of the PPP associates with the nonstationarity of interest rate differentials to produce a stationary relation. On the other hand, we do not reject PPP. We find that PPP cointegrates with inflation differentials. We also find, contrary to conventional wisdom, that (i) equilibrium adjustment occurs between the German and UK inflation rates, while weak exogeneity exists for the German and UK interest rates and the PPP condition, and (ii) three common trends associated with the German interest rate, the UK interest rate, and the PPP condition “push” the system with the German interest rate and the PPP condition playing dominant roles.

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File URL: http://web.unlv.edu/projects/RePEc/pdf/1208.pdf
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Bibliographic Info

Paper provided by University of Nevada, Las Vegas , Department of Economics in its series Working Papers with number 1208.

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Length: 53 pages
Date of creation: Aug 2012
Date of revision:
Handle: RePEc:nlv:wpaper:1208

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Keywords: Purchasing Power Parity; Euro Area; Cointegrated VAR.;

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