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Exchange Rate Misalignment in Pakistan: Evidence from Purchasing Power Parity Theory

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  • qayyum, Abdul
  • Khan, Arshad
  • Zaman, Kair-u

Abstract

In this study we have tested the validity of purchasing power parity hypothesis and exchange rate misalignment for Pakistan over the period 1982Q2-2002Q4. From the empirical analysis we can say that nominal exchange rate is cointegrated with WPI ratio. The cointegration coefficient between nominal exchange rate and the WPI-based price ratio is close to one. Furthermore, the coefficient restrictions are tested using maximum likelihood ratio statistic, lend support for the validity of the long-run PPP. Pakistan has been pursuing trade and exchange rate liberalisation policies from the late 1980s. Through these reforms, Pakistan has successfully eliminated most price controls and liberalised trade. These trade and exchange liberalisation policies allowed the law of one price to work more efficiently as shown by the supportive evidence of PPP. Moreover, the short-run deviation from PPP has frequently occurred, but the long-run validity of absolute PPP could not be rejected. The adjustment coefficient is negative and significant. However, the size of this coefficient is small indicating that the speed of adjustment is very slow. Even though long-run PPP holds, the speed of adjustment is rather slow, implying that misalignment is eliminated in the absence of shocks but only after a substantial period of time. The exchange rate remained undervalued vis-à-vis US dollar since the adoption of managed floating exchange rate system. Finally, the predictive power of these findings implies that exchange rate misalignment relative to PPP would eventually be corrected through commensurate movements in nominal exchange rates.

Suggested Citation

  • qayyum, Abdul & Khan, Arshad & Zaman, Kair-u, 2004. "Exchange Rate Misalignment in Pakistan: Evidence from Purchasing Power Parity Theory," MPRA Paper 2148, University Library of Munich, Germany, revised 2004.
  • Handle: RePEc:pra:mprapa:2148
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    Cited by:

    1. Matthew McCartney, 2015. "The Missing Economic Magic: The Failure of Trade Liberalization and Exchange Rate Devaluation in Pakistan, 1980–2012," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 20(Special E), pages 59-86, September.
    2. Muhammad Awais Bhatti & Noman Arshed & Muhammad Haseeb, 2013. "Performance of CHEERs Based Equilibrium Exchange Rate of Pakistan," Business and Management Horizons, Macrothink Institute, vol. 1(1), pages 17-43, June.
    3. Shehu Usman Rano, Aliyu, 2007. "Real Exchange Rate Misalignment: An Application of Behavioral Equilibrium Exchange Rate (BEER) to Nigeria," MPRA Paper 10376, University Library of Munich, Germany.
    4. ibrahim, waheed & Jimoh, Ayodele, 2012. "Real Exchange Rate and Real Effective Exchange Rate Measurement: Some theoretical Extensions," MPRA Paper 59428, University Library of Munich, Germany, revised 2013.
    5. Khan, Muhammad Arshad & Qayyum, Abdul, 2007. "Exchange Rate Determination In Pakistan: Evidence Based On Purchasing Power Parity Theory," MPRA Paper 6754, University Library of Munich, Germany.

    More about this item

    Keywords

    Exchange Rate Misalignment; Purchasing Power Parity; Pakistan;

    JEL classification:

    • F30 - International Economics - - International Finance - - - General

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