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Policy convergence, the exchange rate mechanism and the misalignment of exchange rates. Some tests of purchasing power parity and generalized purchasing power parity

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  • Lucio Sarno

Abstract

The paper focuses on the convergence issues and the long-run credibility of the European Monetary System (EMS), and, more specifically, on the evaluation of the effectiveness of the Exchange Rate Mechanism (ERM) in generating a stabilizing effect on real exchange rates across member countries. For this purpose, we execute some tests of long-run purchasing power parity (PPP) for an ERM group and a non-ERM group of countries using both the Engle and Granger procedure and the more powerful Johansen cointegration technique. We also execute a test of Generalized PPP, exploiting an idea developed by Enders and Hurn. Testing for PPP in a multicountry setting may be a useful methodology to identify the optimal currency area suggested by the data generation process, on the basis of the reported homogeneity of real exchange rate behaviour of the countries considered.

Suggested Citation

  • Lucio Sarno, 1997. "Policy convergence, the exchange rate mechanism and the misalignment of exchange rates. Some tests of purchasing power parity and generalized purchasing power parity," Applied Economics, Taylor & Francis Journals, vol. 29(5), pages 591-605.
    • Handle: RePEc:taf:applec:v:29:y:1997:i:5:p:591-605
    DOI: 10.1080/000368497326796
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    References listed on IDEAS

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    1. Fratianni, Michele & von Hagen, Juergen, 1990. "The European Monetary System ten years after," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 32(1), pages 173-241, January.
    2. James G. MacKinnon, 1990. "Critical Values for Cointegration Tests," Working Paper 1227, Economics Department, Queen's University.
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    Cited by:

    1. Dimitrios Sideris, 2011. "Optimum currency areas, structural changes and the endogeneity of the OCA criteria: evidence from six new EU member states," Applied Financial Economics, Taylor & Francis Journals, vol. 21(4), pages 195-206.
    2. Laurence Copeland & Saeed Heravi, 2009. "Structural breaks in the real exchange rate adjustment mechanism," Applied Financial Economics, Taylor & Francis Journals, vol. 19(2), pages 121-134.
    3. Daniele Antonucci & Alessandro Girardi, 2005. "Structural changes and deviations from the PPP within the Euro Area," ISAE Working Papers 57, ISTAT - Italian National Institute of Statistics - (Rome, ITALY).
    4. Kocenda, Evzen, 1998. "Exchange rate in transition," MPRA Paper 32030, University Library of Munich, Germany.
    5. Mishra, Ritesh Kumar & Sharma, Chandan, 2010. "Real exchange rate behavior and optimum currency area in East Asia: Evidence from Generalized Purchasing Power Parity," International Review of Financial Analysis, Elsevier, vol. 19(3), pages 205-213, June.
    6. Kocenda, Evzen, 2001. "Macroeconomic Convergence in Transition Countries," Journal of Comparative Economics, Elsevier, vol. 29(1), pages 1-23, March.
    7. Poomthan Rangkakulnuwat & Sung Ahn & Holly Wang & Susan He, 2010. "Extended generalized purchasing power parity and optimum currency area in East Asian countries," Applied Economics, Taylor & Francis Journals, vol. 42(4), pages 497-513.
    8. Makoto Muto & Yoshitaka Saiki, 2020. "Synchronization analysis between exchange rates on the basis of purchasing power parity using the Hilbert transform," Papers 2010.08825, arXiv.org, revised Aug 2022.
    9. Lucio Sarno, 2000. "Systematic sampling and real exchange rates," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 136(1), pages 24-57, March.

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