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Is the Relationship Between Prices and Exchange Rates Homogeneous?

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  • Stephen Hall

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  • George Hondroyiannis
  • Amangeldi Kenjegaliev
  • P.A.V.B. Swamy
  • George S. Tavlas

Abstract

Empirical tests of purchasing power parity (PPP) are implicitly based on the conditions of symmetry and proportionality of the price coefficients. We investigate a separate condition, which we term homogeneity. Specifically, while there may be factors that drive a wedge between prices and exchange rates, when these factors are held constant we would expect a change in exchange rates to be associated with a proportional, or homogeneous, change in prices. To test for the existence of homogeneity in prices, we conduct two experiments. First, we apply a time-varying-coefficient procedure to nine euro-area countries as well as the euro area as a whole during the (monthly) sample period, 1999: M1 to 2011:M3. Second we apply the same procedure to the same group of countries, plus Canada, Japan and Mexico, over the longer period, 1957:M4 to 2011:M3. We find that averages of the price coefficients, corrected for specification biases, are uniformly homogeneous in the long run, providing strong support for PPP.

Suggested Citation

  • Stephen Hall & George Hondroyiannis & Amangeldi Kenjegaliev & P.A.V.B. Swamy & George S. Tavlas, 2013. "Is the Relationship Between Prices and Exchange Rates Homogeneous?," Discussion Papers in Economics 13/13, Department of Economics, University of Leicester.
  • Handle: RePEc:lec:leecon:13/13
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    References listed on IDEAS

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    1. Edison, Hali J. & Gagnon, Joseph E. & Melick, William R., 1997. "Understanding the empirical literature on purchasing power parity: the post-Bretton Woods era," Journal of International Money and Finance, Elsevier, vol. 16(1), pages 1-17, February.
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    3. Li, Kai, 1999. "Testing Symmetry and Proportionality in PPP: A Panel-Data Approach," Journal of Business & Economic Statistics, American Statistical Association, vol. 17(4), pages 409-418, October.
    4. Swamy P. A. V. B. & Tavlas George S & Hall Stephen G. F. & Hondroyiannis George, 2010. "Estimation of Parameters in the Presence of Model Misspecification and Measurement Error," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 14(3), pages 1-35, May.
    5. Shiu-Sheng Chen & Charles Engel, 2005. "Does 'Aggregation Bias' Explain The Ppp Puzzle?," Pacific Economic Review, Wiley Blackwell, vol. 10(1), pages 49-72, February.
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    Cited by:

    1. George Hondroyiannis & Dimitrios Papaoikonomou, 2017. "The effect of card payments on vat revenue in Greece," Working Papers 225, Bank of Greece.
    2. Giorgio Canarella & Stephen Miller & Stephen Pollard, 2014. "Purchasing Power Parity Between the UK and Germany: The Euro Era," Open Economies Review, Springer, vol. 25(4), pages 677-699, September.
    3. Pilbeam, K. & Litsions, I., 2015. "The long-run determination of the real exchange rate. Evidence from an intertemporal modelling framework using the dollar-pound exchange rate," Working Papers 15/19, Department of Economics, City University London.
    4. Janice Breuer & Vikram Kumar & Shyam Suresh, 2015. "Inter-Temporal Purchasing Power Parity," Open Economies Review, Springer, vol. 26(5), pages 869-891, November.
    5. repec:eee:ecolet:v:157:y:2017:i:c:p:17-20 is not listed on IDEAS
    6. M. Ariff & A. Zarei, 2016. "Exchange Rate Behavior of Canada, Japan, the United Kingdom and the United States," Open Economies Review, Springer, vol. 27(2), pages 341-357, April.

    More about this item

    Keywords

    Purchasing power parity; symmetry; proportionality; homogeneity; generalized cointegration; time-varying coefficients.;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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