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The Purchasing Power Parity Approach: Theory, Literature, and Evidence from the ADF-Based and KPSS-Based Tests for the Case of Turkiye

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  • Fatih Çiftci

    (Yozgat Bozok Üniversitesi, İktisadi ve İdari Bilimler Fakültesi, İktisat Bölümü, Yozgat, Türkiye)

Abstract

The main aim of this study is to test, by using alternative tools, the validity of the absolute version of the purchasing power parity (PPP) hypothesis within the context of the Turkish economy for the post-February-2001-period of floating exchange rate regime. Additional aims pursued by the present study are to introduce briefly the PPP approach and review the relevant econometric literature. Using an array of ADF- and KPSS-based traditional and modern test techniques, the econometric implementation part of this paper has primarily been devoted to investigate whether the real TL/USD exchange rate variable is stationary at its level. To that end, four different types of the real exchange rate variable have been constructed, in which two alternate nominal TL/USD exchange rate series measured by the period-average and end-of-period values and two alternate average price series defined in terms of the consumer and producer price indexes were used. The two alternate real exchange rates that use the consumer (producer) price index were calculated by means of the quarterly data that comprise the period of 2001Q2-2022Q2 (2001Q2-2020Q1). Based on the unit-root and stationarity tests, it has been found that the absolute PPP hypothesis is valid only when the possibility of structural breaks is taken into account by using some particular methods. Otherwise, it has been found to be invalid. The secondary empirical analyses of this paper have questioned if there is a cointegration relationship between the variables of nominal TL/USD exchange rate and relative price, again, by using the alternate versions of the two variables and a number of ADF- and KPSS-based techniques. In doing so, the same data-set as above was utilized. Accordingly, the absolute PPP hypothesis has been supported strongly when the potential of a structural break in the model is taken into account, while the support has been found to be weak when the other way is the case. The KPSS-based tests used in the current study have provided more evidence in favor of the validity of the PPP relationship, both in its restricted and unrestricted forms, relative to the ADF-based tests. One of the conclusions implied by the findings of the econometric analyses is that the equilibrium value of the nominal TL/USD exchange rate in Turkiye can be determined more accurately by utilizing the qualified-PPP approach, rather than its standard version.

Suggested Citation

  • Fatih Çiftci, 2024. "The Purchasing Power Parity Approach: Theory, Literature, and Evidence from the ADF-Based and KPSS-Based Tests for the Case of Turkiye," Journal of Economic Policy Researches, Istanbul University, Faculty of Economics, vol. 11(2), pages 115-157, July.
    • Handle: RePEc:ist:iujepr:v:11:y:2024:i:2:p:115-157
    DOI: 10.26650/JEPR1288813
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    References listed on IDEAS

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    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • F02 - International Economics - - General - - - International Economic Order and Integration
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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