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Common trends and generalized purchasing power parity

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  • Enders, Walter
  • Hurn, Stan

Abstract

The theory of purchasing power parity (PPP) has worked poorly during the post-Bretton Woods period. We generalize the concept of PPP (called generalized-PPP, or G-PPP) and posit an equilibrium relationship among groups of real exchange rates. The basic tenants of G-PPP are that real fundamental macroeconomic shocks tend to be non-stationary so that the real exchange rates themselves will tend to be non-stationary. Although bilateral exchange rates are non-stationary, they will be cointegrated if the vector of stochastically trending variables has reduced rank. G-PPP will hold within the domain of a currency area since the individual nations will experience a set of common real macroeconomic shocks. Using data from the industrialized countries during the post-Bretton Woods period, we show that G-PPP holds for various groupings of nations. We estimate the long-run equilibrium relationships among the real exchange rates and the short-run dynamics concerning the international transmission of real disturbances. An interesting finding is that G-PPP does not hold among the set of major European nations. The direst implication is that such nations do not constitute the domain of a currency area.

Suggested Citation

  • Enders, Walter & Hurn, Stan, 1997. "Common trends and generalized purchasing power parity," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 43(3), pages 437-443.
    • Handle: RePEc:eee:matcom:v:43:y:1997:i:3:p:437-443
    DOI: 10.1016/S0378-4754(97)00029-3
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    References listed on IDEAS

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    1. Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
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    Cited by:

    1. EPHREM HABTEMICHAEL REDDA & Paul-Francious Muzindusti, 2017. "Does SADC constitute an optimum currency area? Evidence from generalised purchasing power parity," Proceedings of Economics and Finance Conferences 4807771, International Institute of Social and Economic Sciences.
    2. Sergio Da Silva & Leandro Stocco & J. Anchieta Neves, 2008. "Is Mercosur an optimum currency area? An assessment using generalized purchasing power parity," Economics Bulletin, AccessEcon, vol. 6(29), pages 1-13.
    3. de Truchis, Gilles & Keddad, Benjamin, 2013. "Southeast Asian monetary integration: New evidences from fractional cointegration of real exchange rates," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 26(C), pages 394-412.
    4. repec:ebl:ecbull:v:6:y:2008:i:29:p:1-13 is not listed on IDEAS
    5. Taufiq Choudhry, 2005. "Asian Currency Crisis and the Generalized PPP: Evidence from the Far East," Asian Economic Journal, East Asian Economic Association, vol. 19(2), pages 137-157, June.
    6. Neves, J. Anchieta & Stocco, Leandro & Da Silva, Sergio, 2007. "Is Mercosur an optimum currency area?," MPRA Paper 2758, University Library of Munich, Germany.
    7. Shu-Chen Chang, 2008. "Asymmetric cointegration relationship among Asian exchange rates," Economic Change and Restructuring, Springer, vol. 41(2), pages 125-141, June.
    8. Changmo AHN & Hong‐Bum KIM & Dongkoo CHANG, 2006. "Is East Asia Fit For An Optimum Currency Area? An Assessment Of The Economic Feasibility Of A Higher Degree Of Monetary Cooperation In East Asia," The Developing Economies, Institute of Developing Economies, vol. 44(3), pages 288-305, September.
    9. Ephrem Habtemichael Redda & Paul-Francois Muzindutsi, 2021. "Monetary Union Feasibility in the East African Community: Evidence from GPPP," International Journal of Economics and Financial Issues, Econjournals, vol. 11(6), pages 9-16.

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