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Purchasing Power Parity: the Choice of Price Index

  • Maria Cristina T. Terra
  • Ana Lucia Vahia de Abreu

Looking closely at the PPP argument, it states that the currencies purchasing power should not change when comparing the same basket goods across countries, and these goods should all be tradable. Hence, if PPP is valid at all, it should be captured by the relative price indices that best fits these two features. We ran a horse race among six different price indices available from the IMF database to see which one would yield higher PPP evidence, and, therefore, better fit the two features. We used RER proxies measured as the ratio of export unit values, wholesale prices, value added deflators, unit labor costs, normalized unit labor costs and consumer prices, for a sample of 16 industrial countries, with quarterly data from 1975 to 2002. PPP was tested using both the ADF and the DF-GLS unit root test of the RER series. The RER measured as WPI ratios was the one for which PPP evidence was found for the larger number of countries: six out of sixteen. The worst measure of all was the RER based on the ratio of foreign CPIs and domestic WPI. No evidence of PPP at all was found for this measure

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Paper provided by Econometric Society in its series Econometric Society 2004 Latin American Meetings with number 247.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:latm04:247
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  1. Alan M. Taylor, 2000. "A Century of Purchasing-Power Parity," NBER Working Papers 8012, National Bureau of Economic Research, Inc.
  2. Sarno, Lucio & Taylor, Mark P, 2001. "Purchasing Power Parity and the Real Exchange Rate," CEPR Discussion Papers 2913, C.E.P.R. Discussion Papers.
  3. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  4. Froot, Kenneth A. & Rogoff, Kenneth, 1995. "Perspectives on PPP and long-run real exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 32, pages 1647-1688 Elsevier.
  5. Cheung, Yin-Wong & Lai, Kon S., 1998. "Parity reversion in real exchange rates during the post-Bretton Woods period," Journal of International Money and Finance, Elsevier, vol. 17(4), pages 597-614, August.
  6. Menzie D. Chinn, 1998. "Before the Fall: Were East Asian Currencies Overvalued?," NBER Working Papers 6491, National Bureau of Economic Research, Inc.
  7. Rudiger Dornbusch, 1985. "Purchasing Power Parity," NBER Working Papers 1591, National Bureau of Economic Research, Inc.
  8. Elliott, Graham & Rothenberg, Thomas J & Stock, James H, 1996. "Efficient Tests for an Autoregressive Unit Root," Econometrica, Econometric Society, vol. 64(4), pages 813-36, July.
  9. Takatoshi Ito & Tamim Bayoumi & Peter Isard & Steven A. Symansky, 1996. "Exchange Rate Movements and Their Impact on Trade and Investment in the APEC Region," IMF Occasional Papers 145, International Monetary Fund.
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