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Purchasing Power Parity between the UK and the Euro Area

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  • Giorgio Canarella

    (California State University, Los Angeles and University of Nevada, Las Vegas)

  • Stephen M. Miller

    (University of Nevada, Las Vegas and University of Connecticut)

  • Stephen K. Pollard

    (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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Bibliographic Info

Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2012-46.

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Length: 54 pages
Date of creation: Nov 2012
Date of revision:
Publication status: Forthcoming in Open Economies Review
Handle: RePEc:uct:uconnp:2012-46

Note: Stephen M. Miller is corresponding author
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Postal: University of Connecticut 341 Mansfield Road, Unit 1063 Storrs, CT 06269-1063
Phone: (860) 486-4889
Fax: (860) 486-4463
Web page: http://www.econ.uconn.edu/
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Keywords: Purchasing Power Parity; Euro Area; Cointegrated VAR;

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