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Nonlinear Adjustment, Purchasing Power Parity and the Role of Nominal Exchange Rates and Prices

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  • Joscha Beckmann

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Abstract

Although the literature on purchasing power parity (PPP) is rich in controversy, the relative contribution of prices and nominal exchange rates to real exchange rate movements which restore PPP disequilibria has rarely been put under any close scrutiny. Using monthly data from 1973:01 to 2009:12 from the USA, UK, Germany, France and Japan, this paper as a fi rst step applies a cointegrated VAR framework to test for stationary real exchange rates and linear adjustments in prices and nominal exchange rates. As a second step, ESTR error correction models are fi tted to test whether nonlinear error correctional behaviour characterizes the data. The results clearly indicate that the nominal exchange rate is responsible for the nonlinear mean reverting behaviour in real exchange rates and also mainly drives overall adjustment. Applying dynamic stochastic simulations based on the estimated models, this study also confi rms recent results that the half-life times of real exchange rate shocks are signifi cantly smaller than the consensus benchmark of three to fi ve years.

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Bibliographic Info

Paper provided by Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen in its series Ruhr Economic Papers with number 0272.

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Length: 27 pages
Date of creation: Jul 2011
Date of revision:
Handle: RePEc:rwi:repape:0272

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Keywords: Purchasing power parity; cointegration; nonlinear vector error correction;

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Cited by:
  1. Slim Chaouachi & Zied Ftiti & Frederic Teulon, 2014. "Explaining the Tunisian Real Exchange: Long Memory versus Structural Breaks," Working Papers 2014-147, Department of Research, Ipag Business School.
  2. Joscha Beckmann & Robert Czudaj, 2013. "Oil and gold price dynamics in a multivariate cointegration framework," International Economics and Economic Policy, Springer, vol. 10(3), pages 453-468, September.
  3. Chia-Lin Chang & Hui-Kuang Hsu & Michael McAleer, 2012. "Is Small Beautiful? Size Effects of Volatility Spillovers for Firm Performance and Exchange Rates in Tourism," KIER Working Papers 839, Kyoto University, Institute of Economic Research.
  4. Simpson, Marc W. & Grossmann, Axel, 2014. "An examination of the forward prediction error of U.S. dollar exchange rates and how they are related to bid-ask spreads, purchasing power parity disequilibria, and forward premium asymmetry," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 221-238.

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